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Pipeline constraints limiting the value of Appalachian operators

It’s a Wall Street quandary. It is no secret that the Permian has become the hottest play in the United States with E&Ps competing to acquire acreage, but the companies operating there may not always attract the most attractive multiples from investors.

In January, EnerCom Analytics took an in-depth look at what factors attract premium valuations from the market and found that investors still like 20% or greater growth, but they have become increasingly wary of debt. During their analysis, EnerCom also found that, while Permian players are currently receiving the strongest multiples, the Appalachian operators have the potential for strong price-to-cash flow per share growth moving forward.

Using EnerCom’s 5 Factor Model (5FM), which includes (a) three-year finding & development costs per unit, (b) capital efficiency, (c) operating and general & administrative expense per unit, (d) three-year production replacement and (e) debt to market capitalization, EnerCom ranked E&P companies on their “Performance DNA.”

The below illustrates the Performance DNA for four groups of E&P companies at September 30, 2016, the most recent date for which we have complete data. Using this analysis, the greater the area covered by the polygon, the better the Performance DNA. Components of the five factors were indexed to 100 (i.e. the highest 3-Year F&D costs would receive a 0, and companies with the lowest 3-Year F&D costs would receive a 100). The polygon represents the averages of the five factors by play.

EnerCom Analytics Performance DNA showing stunted Appalachian valuations

The chart on the left illustrates that growth companies with operations in the Appalachian Basin (red polygon), on average, have the strongest Performance DNA, but their equity multiples have them placed on-par with the majority of our universe. The 2014 analysis showed Appalachian Basin players had the strongest Performance DNA three years ago as well, but they were able to get a premium multiple to match.

EnerCom Analytics Performance DNA by basin showing Appalachian Basin with the best valuations in 2014

EnerCom Analytics believes the Appalachian players are not seeing multiples in-line with their Performance DNA in large part because of takeaway constraints in the region. Many companies producing in the Appalachian basin were able to grow their production by 20% or more, but they did not receive premium multiples because their production was stranded.

A number of projects are expected to increase takeaway capacity from the region in the near future, however. In the company’s March investor presentation, Range Resources (ticker: RRC) said it expects takeaway to increase substantially through the end of 2018.

Range Resources Appalachian takeaway capacity

Source: Range Resources

With increased takeaway capacity, Appalachian operators could see their multiples start to match their Performance DNA. Given that the group was outperforming Permian players at the time of its analysis, EnerCom Analytics believes this could translate into price-to-cash flow multiples in excess of the 9.4x that Permian E&Ps currently enjoy.

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