TOP CONTRIBUTORS

Anthony Citarrella

KWK AT A GLANCE

P/E ► -2.15   EV/EBITDA ► -4.00   ROA ► -20.3% AVG ROE ► -101.4% LOW Debt to Equity ► 5.22 VERY HIGH Current Ratio ► 0.770 AVG Interest Coverage Ratio ► -7.38 AVG

 

 

 

 

 

 

Operating through various locations in the United States and a Western Canadian subsidiary, Quicksilver Resources' niche is the development of unconventional natural gas reserves.^[1] Their portfolio, which includes coal bed methane, tight sands gas, and shale gas plays, is predominantly comprised of natural gas and natural gas liquids (as they represent 98% of total reserves).^[2]

With a risky and aggressive acquisition strategy, management has been successful in recognizing and acquiring high-potential sites before their competition. As a result, the firm has managed to acquire cheap acreage and achieve significant growth during the past several years. With these acquisitions, the reserves in northern Texas’ Barnett Shale formation and Canada have grown tremendously, and they now serve as the company’s main vehicle for growth. Management's faith in these high-potential areas is evidenced by the board's significant capital budget increase to $885 million in 2008, ^[3] up from $610 million in 2007 and an average of $275 million for the previous five years.

Business Overview and Financial Operating Metrics

Many of the players in the natural gas industry have acreage positions in Texas' gas rich Barnett Shale formation. Quicksilver, like many of its competitors, is increasingly focused on boosting returns in this area by implementing unconventional extraction processes. These processes, which have only recently become profitable due to the record prices of oil and natural gas, are Quicksilver's forte. In 2008, KWK has announced plans to drill around 200 net wells in the Fort Worth basin along with 165 wells in Canada. ^[4]

Evidenced by the table below, Quicksilver Resources' acquisition strategy has positively impacted some of their key financial measures, with operating profit nearly tripling over the course of three years.

Below is a geographic breakdown of Quicksilver Resources' proved reserves. Notice that the Barnett Shale formation in Texas represents nearly half of their holdings and management views it as an opportunity to leverage the competencies they have already learned from the company's more mature Michigan operations. ^[5]

Trends & Drivers

Management's Strategic Shift

As mentioned earlier, Quicksilver has enjoyed much of their recent success as a result of managerial prowess in acquiring cheap, yet gas-rich reserves. However, now that the company has acquired such attractive leaseholds, it is confronted with the challenge of efficiently developing these new acquisitions and growing by implementing a comparatively low-risk, yet aggressive drilling strategy in Texas and Canada. Moreover, management's dedication to developing these acquisitions is clearly underlying their $885 million capital budget plan in which $790 million will go towards Texas. ^[6] Considering that less than half of their proved reserves are located in Texas, it could be a high risk endeavor.

The Underlying Risks Inherent with Canadian Operations

Currently, KWK's Canadian operations, which focus on the extraction of coal bed methane, are loosely regulated. Therefore, it should be noted that there has been increased concern about the negative externalities resulting from the extraction process. If the company continues to harm the environment in which they operate, they may become subject to penalties such as government sanctions.^[7] Furthermore, in the first quarter of 2008, the cost of production in Canada increased by 25%, largely due to increased transportation costs and the devaluation of the United States dollar which accounted for approximately $1.2 million in expenses for the most recent quarter. ^[8]

Rising Natural Gas Prices

Around 98% of Quicksilver's yearly production and proved reserves are natural gas (rather than oil). The price of these commodities have not experienced the same recent rapid increases as oil. Thus, the company has not experienced the same acceleration of revenue and operating profit as some of its more oil-focused peers. However, in the first quarter of 2008, despite lower volume due to the sale of a northeastern reserve, natural gas sales were nearly 10% higher than the previous year.^[9] Also, as mentioned earlier, Quicksilver's strategy of realizing and pursuing unconventional sites prior to their competition has enabled KWK to build attractive acreage positions in some of North America's most gas-rich regions and this may help yield some promising returns.

Trends in Hybrid and Alternative Energy Technology may threaten the long term price of Natural gas

Rising oil prices have led both consumers and companies to seek out alternative sources of energy and to invest in renewable energy such as nuclear, solar, wind, biofuels, and ethanol technologies. As global consumer demand shifts toward renewable energy sources and incentives to develop long-term solutions to the world's dependence on oil and gas become stronger due to recent environmental concerns over climate change, consumer consciousness and the entrepreneurial profit motive may adversely affect the oil and gas industry. With the advent of hybrid and fuel cell vehicles and the cost of gasoline becoming dangerously high, consumers have become less willing to purchase gas guzzling SUVs as opposed to more fuel-efficient cars.

A substantial drop in the price of natural gas could be catastrophic for Quicksilver's continued expansion and ability to meet long term debt obligations. Currently, because KWK relies on a blend of operating cash flow and external financing to fund its operations, a decrease in the sales price of natural gas would lead to additional leverage. As a result, KWK stands to face long-term materially adverse effects if the oil and gas industry encounters a decrease in demand.^[10]

Competition

As a seller of a commodity product, Quicksilver operates in a highly competitive environment in which all firms are price-takers, selling their gas production at given market prices. Firms generally compete on their ability to drill efficiently and earn high returns on investment through intelligent property acquisition and by keeping operation costs to a minimum.

Below is a table comparing several metrics from some of the main players in the independent oil & gas industry.^[11] It is worth noting that the Energy Information Administration reports that there exists around 170 trillion cubic feet of natural gas proved reserves in the United States. Given this, an estimated "market share" for Quicksilver's 1.24 trillion cubic feet gas reserves would be approximately 0.73%, indicative of the dispersion and fragmentation of the natural gas industry in the US.

Footnotes

1. ↑ KWK 2006 10-K "Business" pg 4
2. ↑ KWK 2006 10-K "Business" pg 4
3. ↑ KWK 2007 10-K "Business" pg 8
4. ↑ KWK 2007 10-K "Business" pg 7
5. ↑ KWK 2006 10-K "Business" pg 4
6. ↑ http://www.qrinc.com/corporate/news/press/2007/121707.pdf
7. ↑ KWK 2006 10-K "Risk Factors" pg 15
8. ↑ KWK 10-Q "Management's analysis and discussion of financial condition" pg 23
9. ↑ KWK 2008 10-Q "Management's discussion and analysis of financial condition" pg 22
10. ↑ KWK 2006 10-K "Risk Factors" pg 14
11. ↑ All data compiled from company annual reports and 10-K's
12. ↑ MMcfe/day, or millions of natural gas cubic feet equivalent, is a measure of the level of production per day that converts oil into the energy-yielding natural gas equivalent using a ratio of 6 to 1 (natural gas to oil)