Value investing is all about trying to find bargains the rest of the market has overlooked. This means value investors will often find themselves going against the rest of the market, searching for hidden gems in the most disliked sectors; looking under rocks hoping to find something valuable.

It is no surprise then that some of the most respected value investors around today have put money to work in the oil & gas sector, which is possibly one of the most contrarian industries places to invest today.

For example, Seth Klarman’s Baupost Group and Glenn Greenberg’s Brave Warrior Capital, have both invested in Denver-based Antero Resources, and significantly added to positions during the second quarter.

In the August 31 issue of Value Investor Insight, Ted Crawford takes a look at the investment case for this oil & gas group and tries to pin down what Klarman and Greenberg see in the business.

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Undeveloped value: oil & gas 

Antero owns 636,000 net acres in the core of the Marcellus Shale and Utica Shale in the Appalachia Basin. On this acreage, the firm has approximately 3,900 undrilled locations giving it the "largest undrilled inventory in the core of Appalachia." Management believes that by developing this inventory, the company can increase production annually by around 20% through the end of the decade.

Unlike other operators, Antero has been extremely active in hedging its production and reportedly has the largest derivatives portfolio in the industry with prices locked in at a 20% premium to the current natural gas price.

As well as Antero's growth potential, the value of the shares is underpinned by a significant 58% shareholding in Antero Midstream Partners, " a master limited partnership that owns pipelines, compressor stations and processing plants that support the parent company's operations." This stake, as well as Antero's derivatives portfolio, are worth nearly 80% of the firm's current market value, $5 billion after tax.

So, how much is the business worth? Antero's management believes that the market is severely undervaluing the group because it is ascribing an absurdly low valuation to its undeveloped shale acreage. As Ted Crawford describes, "Subtracting from the company’s current enterprise value the after-tax, net-of-tax-loss value of its stake in Antero Midstream, the market value of its hedge book, and the so-called PV-8 value of its proved, developed and producing assets leaves $1.1 billion in value ascribed to the company’s 492,000 core undeveloped acres."

On this basis, the market is valuing the acreage  at "$2,300 per core undeveloped acre." Recent transactions, however, have completed at a cost of between $10,000 and $15,000 per acre, 550% above the market implied value at the high end. Applying the low-end valuation to a sum-of-the-parts valuation gives a share price of $32, 65% above the current price.

There's a lot of bad news already baked into Antero's share price at current levels, but the hedge book and deep discount to its sum-of-the-parts value gives investors a broad enough margin of safety to fall back on if things don't go to plan.

undeveloped value

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