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Approach Resources (AREX): A Top-Pick In Small-Cap E&P Space

 February 03, 2013 07:57 PM

(By Mani) Approach Resources, Inc. (NASDAQ: AREX) remains one of the top picks in the small-cap E&P sector despite its shares under-performing the market during the fourth quarter due to questions about its equity offering and the sell-off given the uncertain energy outlook.

The company's core operating area is in the Permian Basin in West Texas, where it has drilled over 695 wells since 2004. It targets multiple, oil and liquids-rich formations in the Permian Basin, operates approximately 148,000 net acres.

While Approach Resources bolsters its production, it continues to focus on cost cutting through improving drilling efficiencies and infrastructure project completions and expects to reduce its well costs to $5.5 million from the current $6.2 million in mid-2013.

In addition, a new valuation benchmark will be provided as Pioneer Natural Resources (NYSE: PXD) announces its JV on the southern Wolfcamp acreage, which is expected in February.

"We currently forecast 2012 production growth to be 25%, which we believe could increase with three horizontal rigs in place next year," Oppenheimer analyst Daniel Katzenberg wrote in a note to clients.

Capex is expected to be $260 million in 2013, down from $295 million in 2012 as spending on infrastructure projects was largely completed during 2012. Currently, well costs are $6.2 million, but the company is targeting costs to decline to approximately $5.5 million by the end of the second quarter of 2013 as infrastructure projects are completed.

The ability to hit this target is an important catalyst for AREX shares to improve its returns. The company estimates it can achieve 20 percent returns at oil prices as low as $65-$70/barrel.

For the third quarter, its adjusted earnings missed consensus due to lower than expected production as a result of downtime at a third-party natural gas processing facility and lower pricing for oil, NGLs and gas. Quarterly production averaged 8.1 million barrels of oil equivalent a day (mboed), an increase of 5 percent sequentially and 22 percent year-over-year (YoY).

Oil volumes continue to show strong growth, up 114 percent YoY while NGL and natural gas were approximately 1 percent. Liquids mix was 65 percent, up from 57 percent a year ago.

The company drilled 12 wells during the third quarter with ten wells being completed. At the end of the third quarter, the company had eight wells waiting on completion.

Fort Worth, Texas-based, Approach Resources is expected to report its fourth-quarter results on Feb.18. Wall Street expects break-even per share on revenue of $36.56 million, according to analysts polled by Thomson Reuters.

Out of 20 analysts covering the stock, 14 of them rate it as "buy" or "strong buy," while five analyst recommend "hold." Meanwhile, one analyst has a "sell" rating on the stock.

Shares of Approach Resources, which trades 47 times its 2013 earnings estimate, were down 15 percent in 2012, compared to a 4.2 percent loss by the peer group, a 13.4 percent increase for the S&P 500 and a 7.7 percent loss for the E&P Index.

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