As many of you know I have been a long time fan of the Atlas family of companies. For those that are interested you can find a brief write up of mine of the parent company, Atlas America (ATLS) here. Of the Atlas America subsidiaries, Atlas Energy Resources (ATN) has been catching the eye of members of the investment community of late. One of its more vocal proponents has been Jim Cramer.
Mr. Cramer’s involvement and discussion of the stock means that the investment thesis behind Atlas Energy Resources is becoming increasingly understood by mainstream investors, which is a great thing for those shareholders that got into the stock long ago. Nevertheless, market pundits such as Mr. Cramer are still failing to differentiate Atlas Energy Resources from its peers. Regarding Atlas Energy Resources Mr. Cramer recently stated that, “Atlas Energy is criminally undervalued" and that at its current price it is an absolute steal. According to Mr. Cramer, the company is a steal because it has 6 trillion cubic feet of domestic natural gas reserves, which give it a $19 upside from its current levels. In addition, Mr. Cramer correctly states that Atlas Energy Resources manages an additional 900 billion cubic feet for other companies, and that it has identified 4-6 trillion more cubic feet of natural gas in Appalachia. Mr. Cramer would have you buy ATN now and cash in on the 7.5% dividend "while you are waiting" for The Street to catch on. In doing so, you are in fact getting a steal as Mr. Cramer suggests but you are at the same time dramatically underestimating the stocks future potential.
Mr. Cramer's primary reason for recommending Atlas Energy Resources is the company’s substantial Marcellus Shale acreage. If you have read my previous article on the Marcellus Shale companies you will remember that Atlas Energy Resources has the second most exposure to the Marcellus of any publicly traded company. That article can be found here. I believe that in order to properly understand the Atlas Energy Resources story you must first understand the company’s competitive advantages over its peers.
If you can achieve this you will not be tempted to sell out on the stock’s next short term advance and will instead be more willing to hold on for the security's likely long term gains. Development of the Marcellus Shale has been slow, even with heavyweights involved in the play such as Range Resources and Chesapeake Energy. The two biggest challenges in developing the Marcellus Shale is the lack of pipeline infrastructure and the limited access to water that is needed to frac the wells.
While both of these issues will be resolved eventually, most Marcellus drillers are seeing delays in their development plans and their stock prices are suffering as a result. Atlas Energy Resources is different, although its unit price is also suffering, suggesting that investors are only following the story’s short-term hype instead of its longer term potential. Atlas Energy Resources already has access to the substantial pipeline infrastructure of Atlas Pipeline Partners, which has been operating in the region for many years. Even more importantly, Atlas Energy Resources owns its own water treatment plants so it has access to all the water it needs. Unlike many other Marcellus drillers, Atlas Energy Resources' Marcellus Shale development plans are running full steam ahead. The company is not limited by the lack of infrastructure or accessible water and as a result deserves a premium multiple.
I believe the most interesting part of the company’s story and something that Mr. Cramer completely missed is that Atlas Energy Resources uses other people’s money to fund its drilling operations in the company's Appalachians operations. This provides the company with a much healthier balance sheet and allows it to explore other opportunities at the same time that it builds out its Marcellus portfolio.
An ordinary natural gas well in Appalachia has an internal rate of return of about 20% at $8.50 gas, which is not too exciting. However, Atlas Energy Resources rate of return is many times higher because of its use of a partnership drilling program in which it develops and contracts with investment partnerships composed of wealthy investors. Atlas Energy Resources guarantees a rate of return to the investors somewhere below the return on the whole well and Atlas Energy Resources then pockets the excess return from the well that hasn’t been guaranteed to investors. As a result, instead of Atlas Energy Resources paying for all of the drilling by itself and getting a 20% annual return, Atlas Energy Resources pays for a very small amount of the drilling costs and keeps a disproportionably large amount of the return. This allows the company to achieve a 72% annual return on its investment. This system works so well because the types of wells Atlas Energy Resources are drilling are very predictable and because the company is spreading the risk over many different wells in the Appalachians. Below you will find a helpful chart courtesy of Deutsche Bank, it will come into discussion a little later on.
How many natural gas companies can get a 72% annual return on their investment you wonder? Not a lot, but the ones that can do it do not do it with boring predictable Appalachian basin wells, they do it by being first movers on the hottest gas plays in the country such as the core Barnett Shale and the Haynesville Shale. If you are not securing leases at the rock bottom prices that only a first mover can get you aren't going to be realizing annual returns on investment anywhere near Atlas Energy Resources levels.
With current lease rates, the Marcellus Shale has the highest return on investment of any known shale play with a whopping 86% annual return at $9.00 NYMEX gas (see chart above). This is many times higher then what a typical Appalachian well would get that is not being operated through Atlas Energy Resources partnership program.
The rate of return in the Marcellus is the highest know internal rate of return because most companies do not have the needed pipeline infrastructure and access to water needed for large-scale development, with the notable exception of course being Atlas Energy Resources. If an 86% return on Atlas Energy Resources' Marcellus wells is not exciting enough, it gets even better. Atlas Energy Resources is soon going to start financing the development of its Marcellus wells using its partnership drilling programs. As with Appalachian wells drilled under the partnership program, you can expect the annual return on Marcellus wells drilled under the partnership programs to be a few times more profitable than wells drilled on a standalone basis by the company’s competitors. In my opinion, we are likely looking at an internal rate of return for the company of 200% to 300% on Marcellus Shale wells drilled under Atlas Energy Resources' partnership drilling programs.
Atlas Energy Resources continues to raise record amounts of capital from outside investors in its partnership drilling programs. In fact, Atlas Energy Resources keeps increasing its own guidance for the amount of partnership capital it will be able to raise. This is a good sign for the company’s unit holders as it means that management will be able to continue its history of delivering outsized gains for its stakeholders.
More important than Atlas Energy Resources' significant Marcellus acreage is Atlas Energy Resources' ability to significantly enhance the rates of return on any oil or gas well via its partnership drilling programs. This is an incredibly significant competitive advantage and something that Mr. Cramer should look into. The fact that they have access to the regions best infrastructure only makes the story more exciting.
As Mr. Cramer suggests, I am content to cash in on Atlas Energy Resources' 7.5% distribution while I wait for The Street to catch on. But Atlas Energy Resources seems to be even more "criminally undervalued" than Mr. Cramer realizes.
Disclosure: Long ATN, AHD, ATLS
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