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Is Painted Pony Petroleum Limited (PPY) A Painted Bubble Filled With Natural Gas?

Any successful investor must separate the hype from the fundamentals. The dot-com and the housing bubbles remind us how detrimental a bubble can be for our portfolios. However, a speculative investor is free to gamble on any stock. An analyst can also be bullish on grossly overvalued stocks for several reasons which are not always for the retail investor’s benefit.

As a fundamentalist investor, I don’t buy Painted Pony Petroleum Limited (CVE:PPY) at $9.50. Painted Pony is a gas weighted producer who is grossly overvalued for the same reasons Africa Oil was grossly overvalued at $10.70 two months ago when I analyzed it in my article. The comments from Africa Oil’s bulls are at the bottom of that article. However, the fundamentals always prevail and the precipitous fall occurred. It’s very difficult to move opposite to the mass but it’s highly rewarding.

EOG Resources Inc (NYSE:EOG)The Fundamental Approach

1) Natural Gas Glut: EOG Resources Inc (NYSE:EOG)’s CEO Mark Papa believes that the natural gas prices will not rebound soon, but he sees them depressed for the next years. This is why, he is shifting his company away from gas and towards oil. This glut hurts the netbacks of the producers and this winter doesn’t seem to be cold enough to push the gas price significantly higher. Painted Pony Petroleum Limited (CVE:PPY) is heavily exposed to gas.

2) Lack Of Oily Acreage: Despite this pessimistic outlook, the company keeps increasing the gas percentage of its total production. The production was 75% gas weighted in Q2 2012 and it is 77% gas weighted currently. Thus, the company keeps adding on the wrong side of the equation instead of adding on the oily part. This implies that its land isn’t oily which is strengthened by:

A) The company finished operations recently on its first exploratory well targeting Viking light oil. This well failed to produce commercial volumes of oil and instead flowed gas.

B)  The ROR (Rate of Return) for its Bakken wells is as low as 41%.

C) Although the company provides numerous details about its gassy Montney acreage, it doesn’t provide any details (decline rate, IP rates etc.) about its Bakken and Mississippian light oil projects.

D) The company said last summer that it completed drilling operations on an exploratory test at Flat Lake with prospective zones in several formations. The completion operations were expected to commence by August 2012. However, it hasn’t released any update on this well so far although seven months have passed. If the results were good, the company would let investors know.

These are clear indicators that the company is lacking oily acreage and this must concern any buyer. If it wants to become oilier, it has to acquire an undervalued oil-weighted junior like Second Wave Petroleum or Arcan Resources Ltd. (CVE:ARN) that own the oil-rich Beaverhill Lake formation. After Crescent Point Energy’s purchase in 2012, Petrobakken Energy also bought recently a significant stake in Arcan Resources targeting Arcan’s oil-rich acreage in Swan Hills.

3) Let The Numbers Speak: Painted Pony has been losing money. The Enterprise Value (EV) is $850M and the estimated annual Funds from operations (FFO) are 40$M at best. The production is 8,100 boepd (77% gas).

So it trades for a staggering $105,000/boepd and 21x the FFO. Both ratios are whopping for any gas weighted player let alone a junior one. The company has also 149 MMboe 2P Reserves (December 2011) which means a fair $5.7/boe for such overly gassy reserves (80% gas).

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