Does Penn Virginia Deserve Such A Low Multiple?

The last 12 months have not been kind to smaller gas-focused E&P companies. With strong production across the country, prices are as low as they've been in almost three years and many companies continue to drill so as to hold onto leases. Making matters worse, exploiting shale gas formations requires considerably more expensive wells and procedures, and energy service companies like Halliburton (NYSE:HAL) have not been in a hurry to cut prices. All in all, it has been an ugly set-up and an ugly market for Penn Virginia (NYSE:PVA).

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In the Right Places
At first glance, it would seem that Penn Virginia has focused on the right markets. The company has a large position in the Eagle Ford region of Texas, an area that has attracted noteworthies like Apache (NYSE:APA), Exxon Mobil (NYSE:XOM) and CNOOC (NYSE:CEO). Penn Virginia also operates in well-known productive regions like the Granite Wash of Oklahoma and Pennsylvania's Marcellus, as well as holding positions in the Texas/Louisiana Haynesville shale. (For related reading, see Oil And Gas Industry Primer.)

But What About the Execution?
Location may be everything in real estate, but it is only part of the equation in energy. Penn Virginia may own the rights to drill in areas close to the operating areas of companies like Exxon and Ultra Petroleum (NYSE:UPL), but the results have not been as favorable. Said differently, the well productivity and decline curves for Penn Virginia's assets just haven't compared very favorably to those of many other operators in the same formation.

Unfortunately, this is a real problem when it comes to long-term value estimates. E&P companies don't get discounts from the drilling companies just because their wells don't produce as well and these are rather expensive wells to drill. To wit, it can cost upwards of $8 million to drill a well in the Eagle Ford and current natural gas prices are just brutal on companies that cannot produce as much as their peers and rivals.

At the same time, Penn Virginia has had its issues with its operations as well. Delays in drilling and completion have led to downward production revisions, and analysts seem rather down on Penn Virginia's ability to really wring value out of its acreage.

How Much Discount Is Fair?
Certainly, Penn Virginia has some challenges and obstacles to reaching its potential. The company has not performed as well as many of its peers and the company faces a nasty one-two punch of rising service costs and low-selling prices. The question, though, is whether the Street is overly punishing these shares.

Small/mid-cap E&P companies have traditionally traded at about six times forward EBITDA estimates. Right now, Penn Virginia trades at around four times the average EBITDA estimate. What's more, the company also looks seriously undervalued on an EV/BOE basis. In other words, the Street assigns less value to the oil and gas that Penn Virginia has in the ground. (For related reading, see 5 Common Trading Multiples Used In Oil And Gas Valuation.)

The Bottom Line
Are investors making too much of Penn Virginia's problems? On one hand, the company has been acquiring more Eagle Ford acreage at attractive prices, and these natural gas prices don't seem sustainable on a long-term basis. On the other hand, there are no shortage of alternative ideas out there and some of the very best analysts (as measured by Institutional Investor votes) are pretty down on the prospects of this name.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.