Thursday, October 29, 2009

Petroquest Energy (NYSE:PQ): Compelling Valuation with Near-Term Catalysts; Upgrading to Overweight - J.P. Morgan

J.P. Morgan is out with a major call on Petroquest Energy (NYSE:PQ) upgrading it to Overweight from Neutral with a $12 price target.

The 21% stock price decline over the past week offers an attractive entry point for investors, in JPM's view. Catalysts include the near-term drilling and completions of four Woodford Shale wells and the results of a Gulf Coast exploration well. The company has acreage in East Texas that is 14 miles from CHK’s recently announced 9.4MMcfepd Bossier Shale well, so PQ has potential in the Bossier as well as the Haynesville.

Re-starting Woodford drilling. PQ re-started its drilling program in the Woodford two weeks ago. During 4Q09, PQ plans to drill and complete two wells and complete another two wells that it drilled last year. The well it is currently drilling was AFE’d at $4.1 MM. The company’s current plan is to continue utilizing 1 rig in 2010 to drill 8 wells, and PQ might add a second rig during 1H10.

Approaching TD at Whistling Straits. PQ is currently drilling its Whistling Straits prospect and is close to TD. Whistling Straits is high risk, with an expected chance of success of 25-30%. However, the dryhole cost of the well is $1.9MM net to PQ with un-risked net reserves of ~25 Bcfe and the potential to add ~10 MMcfepd of net production.

Rights to Haynes ville uncertain but not to the Bossier. PQ has 23,900 net acres in southeast Panola County, Texas, and it has rights to the Bossier Shale on all of this acreage. PetroQuest’s acreage is 14 miles northwest of CHK’s Bossier Shale well that had an IP rate of 9.4 MMcfepd. The company has rights to the Haynesville on at least 1,100 net acres and possibly more depending on its partnership with CVX. Based on other operators’ publicly disclosed maps, PQ’s acreage appears to be on the edge of both the Bossier and Haynesville Shale plays. JPM gives PQ no credit for Bossier potential and value PQ’s Haynesville potential at ~$1/share.

Compelling valuation. JPM's $12 price target implies 100% upside from the current share price compared to the group's median upside potential of 26%.

Thesis. PQ currently is trading at a discount valuation to the group. The group is trading at 78% of our NAV, and PQ is trading at 48% of NAV. The market perceives greater risk in the name, but the company’s 2009 cash build-up and equity offering have greatly improved its liquidity and debt metrics. Operationally, the company’s two gas shale plays (Woodford and Fayetteville) have shown steadily improving results. PQ expects to keep its Gulf Coast/Gulf of Mexico production flat and could get a boost with successful exploration from that region.

Notablecalls: There is very little doubt in my mind this one will fly today.

Petroquest has always been a kind of a controversial E&P player but with a firm the size and reputation of J.P. Morgan giving its blessing people will scramble to own it. The co sold 10M shares back in June so the financial position is now secure and the co can again spend money on exploration again.

- Low valuation vs. peers

- Catalysts on the horizon

- J.P. Morgan's target price is now about TWICE that of the competition. This is bound to generate strong interest.

I think PQ will trade up 10% today (if not more), putting $6.50 in play.

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