July 15, 2010 - 10:52pm EST by
2010 2011
Price: 27.50 EPS $0.00 $0.00
Shares Out. (in M): 47 P/E 0.0x 0.0x
Market Cap (in $M): 1,300 P/FCF 0.0x 0.0x
Net Debt (in $M): 340 EBIT 0 0
TEV ($): 1,640 TEV/EBIT 0.0x 0.0x

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We are recommending a long position in Comstock Resources (CRK).
Comstock Resources (CRK) is a Texas based oil and gas producer. Comstock derives 90% of its reserves and production from natural gas and is completely un-hedged going forward with one of the lowest operating cost profiles in the industry. Comstock's main asset is the Haynesville shale gas field in Louisiana and Texas.  Shale gas has been a game changer for the natural gas market. Shale gas, particularly in the United States, is plentiful, economic and offers substantial growth opportunities vs. other sources of energy. Current spot prices are below the level necessary to create an acceptable return on investment in the industry. Consequently, in the long run, there should be some upward pressure on gas prices as drillers shut down projects. While we are not massively bullish on natural gas pricing in the short term, Comstock's pristine balance sheet and status as a low cost producer should enable them to thrive in our relatively conservative forecasted gas price environment.
Comstock has been an aggressive acquirer of proven oil and gas reserves since 1991.  Since that time, Comstock has purchased approximately 1 trillion cubic feet (equivalent) of gas and oil reserves at an average cost of $1.14 per thousand cubic feet. Haynesville represents the key driver in Comstock's future performance, with forecasted production growth greater than 20% in 2010 and 15% in 2011.  Comstock owns over 70,000 acres in the Haynesville area and it is likely that the company could increase proven reserves well in excess of 100% over the next few years.
Unlike many of its peers, Comstock has been able to grow production and reserves through internal cash flow given the low cost nature of its assets and the availability of organic financing. In addition to operating cash flows, the company intends to monetize it's almost 10% stake in Stone Energy (worth approximately $60 million today) as well as the possible divestiture of some of its oil assets (potentially worth around $150 million). The company currently has around $200mm in cash on the balance sheet with an available undrawn revolver of $500mm.  Current available liquidity along with potential divestments could be utilized for debt retirement (currently around $470mm) or the acquisition of additional, potentially distressed, leaseholds in Haynesville.
In terms of Valuation, we forecast that CRK should produce around $5.25 in 2010 CFPS under estimated gas and oil prices of $4.50/MMbtu and $75/bbl, respectively.  We see the stock currently trading at around 5x CF with forecasted CAGR volume growth in the mid-teen's for the next few years.  If gas were to move back to our longer-term target of $5.50/MMbtu, we think CFPS will easily be able to eclipse $7-8/share.  We think being able to purchase a low-cost producer that should grow volumes by a CAGR in the mid-teens over the next few years at 3-4x CF represents a compelling investment opportunity.  The company will not be producing much FCF as they will wisely be reinvesting into new Haynesville wells which should provide excellent returns on capital.    
Going forward, the dynamics of the natural gas market are tricky. The rapid increase in production and reserves (as a result of the advent of shale gas) has dramatically changed the relationship between supply/demand fundamentals for the gas industry. Additionally, the flurry of previous acreage acquisitions has spurred a significant drilling program to meet lease requirements. We believe current low gas prices combined with expiring drilling commitments should lead to a rollover in the rig count which should balance the supply and demand, pushing prices toward a higher long term equilibrium.

Furthermore, discretionary producers have directed capital investments towards oil and away from gas. At current prices, most oil producers have a 50-60% annualized return while most gas producers have a 10% return and many are losing money. Much of the price differential is due to natural gas' fundamental transportation disadvantage to oil. While we believe the short term fundamentals for gas remain challenging over the next few months, we expect the rollover in drilling; the shift in capital from gas to oil and increased industrial demand will underpin our long term assumption of $5.50/MMbtu as we believe that this is a minimum price to incentivize production that we believe will eventually be required.


- Divestment of Stone Energy position
- Divestment of non-core oil assets
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