Memorial Resource Development Stoked On NatGas Output

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Memorial Resource Development scored high grades with investors in its first report card to shareholders as a public company.

The independent oil and gas producer's stock rose 5.4% by the closing bell on Aug. 6 after the company posted second-quarter earnings that sailed past views amid a hefty spurt in production from horizontal drilling in the Terryville Field (also called the Terryville Complex), in northern Louisiana.

Earnings, adjusted for noncash items such as unrealized hedge losses and loss on sale of properties, came in at 23 cents a share, according to Thomson Reuters. That price handily beat the 15-cent consensus view of analysts. The company reported overall adjusted net income of $44.8 million.

Total revenue roughly doubled to $113.3 million, up from $56.9 million a year earlier.

Wall Street sees bright prospects for the company, whose stock started trading on June 13. Analysts polled by Thomson Reuters forecast that earnings will increase 50% in 2015 to $1.02 cents a share from an estimated 68 cents for full-year 2014. They see a 43% rise in 2016 to $1.46 a share.

Rich Territory

Memorial Resource ( MRD ) is primarily a natural gas producer with the majority of its activity in the Terryville Field, where the company is targeting what it calls "overpressured, liquids-rich" natural gas opportunities in multiple zones of the Cotton Valley formation. As of Dec. 31, its total leasehold position was 205,818 net acres, of which 96,733 are in the Terryville Field.

The company is also developing the Cotton Valley formation in eastern Texas and the Niobrara and Williams Fork formations in Colorado's Piceance Basin.

Also as of that date, it had 1,582 gross identified horizontal drilling locations, of which 1,431 are located in the Terryville Field.

The Terryville Field is "one of North America's most prolific natural gas fields, characterized by high recoveries relative to drilling and completion costs, high initial production rates with high liquids yields, long reserve life, available infrastructure and a large number of service providers," according to a company filing with the SEC.

In the second quarter, Memorial's average daily production soared 86% from a year earlier. It rose 32% from the prior quarter. The increase was primarily driven by its drilling activity in the horizontal development of the Terryville Field. As of Aug. 5, it had a total of 32 horizontal wells producing from the Terryville Field.

The company currently operates six rigs, all of which are located in the Terryville Field.

Stock market investors have given the company a warm reception. Its shares have climbed around 32% above its initial public offering price.

Natural gas-focused exploration and production company IPOs such asRice Energy ( RICE ) early this year andAntero Resources ( AR ) last year have also done well, says Renaissance Capital analyst Nick Einhorn. Those companies' shares are up 36% and 27% from their respective offering prices.

What's the draw?

"In general, investors who look at E&Ps (energy explorers and producers) get excited about companies with good production growth," he said. "All three companies have that."

Memorial plans on upping its production growth. It expects a drilling program dominated by the Terryville Field to drive 55% annual production growth from 2013 through 2016, wrote Stifel Nicolaus analyst Michael Scialla in his initiation report on the company. Unlike most of its competitors, he adds, Memorial plans to fund its strong growth with internally generated cash flow.

"That annual growth of 55% per year is attractive," Scialla told IBD. "It's better than what most companies are generating with their internal cash flow. They have big potential inventory beyond the three-year plan that could drive their stock a lot higher."

The three-year plan is based on 150 drilling locations at Terryville, he adds, while the company has identified a total inventory of 1,500 locations.

Memorial is in a favorable position to get good prices for its natural gas, Scialla adds.

He says that while natural gas prices have been weak over the past five years because so much natural gas has been found in the U.S., Memorial has a pricing advantage given its activity in the Terryville Field.

The reason: "Their wells are extremely prolific, and the well economics are good even at a low natural gas price," he said.

The Terryville Field, Scialla adds, is located in northern Louisiana, where there's a lot of processing infrastructure and excess pipeline capacity to transport the natural gas to other parts of the country.

With that strong takeaway capacity, dry gas from the northern Louisiana area receives the benchmark Henry Hub price for natural gas, which is around $4 per thousand cubic feet (Mcf), says Scialla.

In contrast, the big growth area for natural gas in the Northeast, where the Marcellus Shale is located, does not have enough pipeline capacity to get that gas to market during nonwinter months when local demand declines. So Marcellus prices have been "very weak," Scialla said.

Memorial's Terryville wells are generating strong returns.

Based on 30-day rates, 20 of the first 24 wells that Memorial drilled in the Terryville Field ranked in the top 2% of all wells drilled in the U.S. in that time period, in terms of the amount of gas produced, with an average payout of 7.2 months, says Scialla.

Strategy Pays Off

Einhorn says that Memorial's internal rate of return on its investments in drilling and operating its wells is strong at over 200% in some cases, though it varies.

"There are few E&Ps that are able to achieve 200% well IRRs (internal return rates)," he said.

Memorial entered the Terryville Field via an acquisition from Petrohawk Energy in 2010 and has done multiple bolt-on acquisitions and in-fill leases to build its current position.

Einhorn says that other companies, such as industry giantsBP ( BP ),Chevron ( CVX ) andAnadarko Petroleum (APC), are operating in the broader area of the Cotton Valley formation, but that Memorial Resources "has made the case" that no other company has made to operate in the Terryville Field.

"They bought all of it," he adds.

Einhorn says that Memorial's growth prospects look good for the near term.

"The risk is they're staking their growth on one field, and it may not play out the way they think it will, or there may end up being only so much natural gas they can get economically," he said. "For right now, though, the business looks good."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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