Quest Resources: On a quest for an undervalued resource
As energy policy quickly emerges as a hot topic of debate on the minds of voters in the 2008 presidential election, the oil and gas exploration industry has been thrust into the spotlight. For better or for worse, this theme will remain dominant for some time to come, and should put the spotlight on small-cap companies such as Oklahoma City-based Quest Resources (Nasdaq:QRCP).
At a market cap of $209 million, Quest is a fully integrated exploration and production company positioned in the Cherokee Basin of southeast Kansas and northeast Oklahoma. It was incorporated in 1982 and today has two distinct business segments: gas and oil production, and the gathering, processing, transporting and selling of natural gas.
The company conducts its gas and oil production segment through its Quest Energy Partners (Nasdaq:QELP) subsidiary. This subsidiary works to develop coal bed methane in a 15-county region in the Cherokee Basin, where it is one of the largest producers of natural gas with an average net daily production of over 50 million cubic feet equivalent (Mmcfe). At the end of 2007, this division had more than 2,200 gross gas wells in operation and was looking to drill and connect another 325 this year.
Quest currently operates its natural gas pipelines business segment through Quest Midstream Partners, a privately held subsidiary that could go public before the end of 2008. Midstream Partners owns approximately 2,000 miles of natural gas gathering pipelines and over 1,100 miles of natural gas pipelines in Oklahoma, Kansas and Missouri.
Despite a recent pullback in its share price, Quest Resources has put together a remarkable run this year for its shareholders. Year-to-date, Quest’s common stock has risen 25%. The company’s operating results have played an integral role in the success of its stock price.
In May, company management reported record first-quarter results that included a decline in earnings. The net loss for the quarter was $11.6 million, but all of this loss can be attributed to the non cash change in fair value of derivative charge of $22 million. Total revenue rose by 63.6% as the company benefited from organic production growth, higher realized natural gas prices, and its KPC interstate pipeline which was acquired in November 2007 from Enbrdige Pipelines.
The company’s gas and oil segment continued to boom during the quarter as its total net natural gas equivalent production averaged 55.6 million Mmcfe per day; a 34.3% increase from an average of 41.4 Mmcfe per day in the year-ago quarter. Growth from the natural gas pipelines segment was off the charts. Revenue for this division increased by 97.5% to $15.6 million in the first quarter of 2008 compared with $7.9 million in the first quarter of 2007.
Quest’s path of expansion is unlikely to end anytime soon. In June, the company paid $140 million to purchase privately held, PetroEdge Resources. PetroEdge has approximately 67,000 acres in the Marcellus Shale play, an untapped reservoir of natural gas located in the Appalachian Basin.
One analyst believes that the market has yet to recognize the full value of this acquisition. “Quest Resources has quickly emerged as a big player in the Marcellus Shale play,” Mark Lear, an analyst for Sidoti & Company, wrote in a July 2 research note. “We think the substantial discount the market is now placing on this large foothold in the Marcellus shale play (roughly $400 per acre) offers investors a compelling entry opportunity.”
Lear currently has a “buy” rating on shares of Quest Resources with a price target of $15. On Thursday, shares of Quest closed at $8.90. For 2008, Lear is looking for Quest to grow its revenue by 56.6% over its full-year 2007 results. In 2009, he is projecting revenue to rise another 35.1%.
One risk for investors to keep in mind with Quest is the recent volatility in energy prices. Quest has seen its share price trade in a trend similar to that of the price of natural gas. Since the price of natural gas has begun to experience a bit of a pullback this month, so has the price of Quest shares.
Despite the risk of volatility in commodity prices, Quest still offers investors a lot of upside potential over the long haul via its projected revenue growth. The stock is also a sound value play in light of the market’s discount on the company’s PetroEdge acquisition. It will certainly be an intriguing company to watch in the quarters ahead.
