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Steven Ralston, CFA
Drilling at Gibson Gulch - Positive Impact expected on Dejour’s valuation
With Dejour (DEJ) having filed a Master Development Plan with the Bureau of Land Management, 16 natural gas wells per year are expected to be drilled into the Williams Fork structure starting in the fourth quarter of 2011 (or roughly 4 wells per quarter). Sometime in the first quarter of 2012, the company plans to frack the first group of approximately 8 wells that were drilled during the fourth quarter of 2011 and the first quarter of 2012.
Importantly, as the wells begin to produce, the natural gas reserves associated with these wells become proved developed producing reserves (PDs or PDPs) instead of proven undeveloped reserves (PUDs). Our valuation analysis utilizes the NAV value of all proven reserves, both developed producing and undeveloped. Being based only on proven reserves, the NAV is calculated using the PV10 value of reserves, that is, the present value of pre-tax estimated future revenues generated from proved reserves, using prices without escalation and discounted at 10%.
However, we are cognizant that there are nuances concerning the quality of reserves that are not captured in our valuation model. One such feature is that by treating PDs and PUDs similarly, our model does not capture some of the inherent risks of PUDs. Since uncertainties exist about the ultimate conversion of PUDs to PDs, there is an inherent discount valuation related to PUDs that must be considered.
In the case of Dejour, the majority of proven reserves are undeveloped ($83 million of the $108 million). However, these PUDs are within or adjacent to a known producing gas field. In addition, Williams Companies is extending a pipeline from its Grand Valley gathering system to the Kokopelli Field, where Dejour’s PUDs are located. This both reduces most of the uncertainties related to the PUDs and also provides an efficient method to transport Dejour’s natural gas into a large-scale, high-volume distribution system.
We expect a positive valuation increment in the marketplace as PUDs become PDs. When the uncertainties associated with PUDs abate, the discount to NAV that pertains to the PUDs at Gibson Gulch will be reduced or be entirely eliminated. As the PUDs become producing wells in the first quarter of 2012, the marketplace may not only eliminate the discount to NAV of those 8 wells, but also reduce or eliminate the discount related to a portion or all of the other 212 PUDs located at Gibson Gulch. As the certainty of the value of the PUDs increases, we expect the valuation of Dejour’s stock to approach Net Asset Value.
Dejour’s NAV is estimated to be $125 million ($1.03 per share). The $125 million is attained by adding the company’s assets of $20 million of land (at cost), $108 million of PV-10 Proved Reserves and net cash of $1.5 million and then deducting $4.5 million in debt (listed as a current liability on the company’s balance sheet). Therefore, our target price is $1.00 per share. We continue to rate Dejour an Outperform.
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