Dr. Albert Bartlett: Arithmetic, Population and Energy
9th Grade Math is Used to Describe Infinite Growth in a Finite Environment

Read the transcript as you listen to the video segments:
Transcript, Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7

If you have RealPlayer you can also access the video Here.
You can also download the Audio (mp3) Here.

This is a very interesting presentation by retired Professor of Physics from the University of Colorado in Boulder, Dr. Albert Bartlett.

ARD Closes at Record High of $43.81
Record Close is also the Intra-Day High

Can GMXR and ARD be Compared to Determine Valuation, Fundamentals, Performance and Margin of Safety?

One investor questions the legitimacy of comparing the two companies by stating, "They are completely opposite focused investments (oil versus natural gas). Anyone who would try to compare them is living in a dream world or is looking through blinders."

Here is my response.

Why Owning GMXR Shares is a Risky Proposition

Preferred Stock Offering
The latest GMXR 10Q stated on page 10, "On August 8, 2006, we sold 1,800,000 shares of our 9.25% Series B Cumulative Preferred Stock at $25.00 per share. Additionally, the underwriters exercised their option to purchase up to an additional 200,000 shares of Series B Cumulative Preferred Stock, resulting in a total offering size of $50 million. The closing of the sale of the 2,000,000 shares occurred on August 11, 2006."

The 10Q went on to state, "The initial annual dividend on each share of Series B Cumulative Preferred Stock is $2.3125 (an aggregate of $4,625,000) and is payable quarterly..."

Lets do the math:

$25(preferred share price) X 0.0925 (interest) = $2.3125

$2.3125 / 4 (quarterly dividend payments) = $0.5781 per quarter.

2,000,000 (preferred shares) x $0.578125 (dividend/share) = $1,156,250 dividend payment per quarter.

In other words the GMXR preferred stock (2,000,000 shares outstanding) will effectively REDUCE GMXR net income by an amount of $1,156,250 each quarter. Since share price is based on EPS longterm, we can expect GMXR share price to be impacted negatively. This fact should be underscored given the fact that the dividend payment each quarter is a significant percentage of quarterly net income.

How would the full dividend payment of $1,156,250 have affected Q3'06 net income and eps?

GMXR net income (before dividend payment) for Q3'06 was reported as $2,860,905. If we factor in the full dividend payment that will be due each quarter the net income available for common shares would have been reduced to:

$2,860,905 - $1,156,250 = $1,704,655

With 11,380,283 fully diluted common shares outstanding the EPS would have been:

$1,704,655 (net income) / 11,380,283 (common shares) = $0.14

In other words EPS for the GMXR common shares (fully diluted)would have been $0.14 after a dividend payment to the preferred stock holders.

What would the EPS have been for common shares if there was no preferred stock?

$2,860,905 (net income before preferred payment)/ 11,380,283 (common shares) = $0.25.


In other words, GMXR common shares would have had EPS of $0.25 in the absence of any preferred stock dividend payments.

In conclusion, we are looking at a situation where GMXR common stock shareholders would have been penalized $0.11 per share in earnings if the full dividend payment were paid out in Q3'06. This effectively would have reduced earnings per share by 44% from $0.25 to $0.11 per share. This reduction in EPS increases the risk of holding the GMXR shares. (Margin of safety has already been eroded as previously discussed in an earlier post.) Any softness in the price of natural gas will magnify the negative impact of the preferred stock dividend on GMXR earnings per share.

ARD Closes at Record High of $42.47
Why ARD is Really a $53 Stock Today by Virtue of Wall Street 2007 Earnings Estimates

On the GMXR board one poster was wondering why GMXR shares were drifting lower when he wrote, "I see GMXR suffering from some profit taking, especially a couple days the last week or so. Is there any news on the horizontal drilling that pushes it so much lower on days when natural gas and oil are relatively flat. Thanks."

My response is as follows...

Read my blog and type in keyword search, "GMXR." You learn a little bit about why GMXR is overvalued at current price of $42.23.

Here is a good start

GMXR has a forward P/E of 24.4 at current price of $42.23. This is assuming the consensus estimate of $1.73 for FY2007 is correct. Personally I don't see GMXR coming in above $1.25 for FY2007. But to be open-minded lets assume GMXR can come in at $1.73. (Reasons I don't see GMXR coming in above $1.25 eps for FY2007 is the fact that GMXR is paying dividends to the pref.stock holders. Also GMXR has a relatively high cost structure for being a gas producer. Also I have very little confidence in mgmt. They are NOT a talented bunch.

Lets assume $1.73 for FY2007 (to make the die-hard GMXR shareholders happy.)

For the first 9 months of 2006 GMXR had a pretty good increase in oil and gas production. Note that ARD had an increase of 116% YoY vs GMXR increase of 113%:


Chart 1 (Click on image to enlarge)


However, the GMXR earnings per share percent change (YOY) for 9 months ended Sept 30, 2006 was sub-standard. ARD exceeded GMXR EPS during this period by a margin of over 306% (ARD had over 4X the EPS growth of GMXR during this period):


Chart 2 (Click on image to enlarge)

GMXR should have better eps growth given that they had "pretty good" oil and gas production YoY. Part of the problem is the high cost structure of GMXR. Note how ARD has a EBIT margin that is 69% higher than GMXR (ARD 66% EBIT margin vs GMXR 39% EBIT margin.)


Chart 3 (Click on image to enlarge)

Given the fact that:
1. ARD has SUPERIOR Oil and gas production growth in the 9 months ended September 30, 2006 than GMXR and:

2. ARD had over 4X the EPS growth of GMXR during this 9 month period and:

3. ARD has an EBIT margin that is 69% HIGHER than that of GMXR. Keep in mind the EBIT margin does NOT factor in the pref. dividends that are paid to the pref. stock holders. When you factor in the dividends GMXR must pay the pref. shareholders there is even less net income left over for GMXR common stock shareholders and:

4. ARD does not have any pref stock dividend payments like GMXR. This has the effect of increasing growth in earnings power....and

5. ARD has every bit as bright of future as GMXR. Actually that statement is extremely sugar-coated. IF the truth be known: ARD has a future that is much much brighter than that of GMXR with better future production, revenue, net income and earnings growth than that of GMXR. And...

6. Given the fact that GMXR has a forward P/E of 24.4 (even after today's steep decline); ARD only has a forward P/E of 14.8; The average P/E of the peer group** was 18.9; then...


Chart 4 (Click on image to enlarge)

Be it resolved that ARD should have a MINIMUM 2007 Forward P/E of 18.9 (the peer group average) and GMXR should have a MAXIMUM 2007 Forward P/E of 18.9 (the peer group average.)

With GMXR estimated 2007 earnings of $1.73 the current fair market value should be:$1.73 X 18.9 (Forward P/E)= $32.69

With ARD estimated 2007 earnings of $2.81 the current fair market value for ARD should be:$2.81 X 18.9 (Forward P/E) = $53.10

Based on today's closing prices of:
GMXR: $41.99
ARD: $42.47

GMXR is OVERVALUED by:
$41.99 - $32.69 (Fair Value) = $9.30
This represents an OVERVALUATION of $9.30. Based on fair value of $32.69 GMXR shares have 22.1% depreciation potential.

ARD is UNDERVALUED by:
$53.10 - $42.47 = $10.63
This represents an UNDERVALUATION of $10.63. With a share price of $42.47 ARD shares have 25% appreciation potential.

To summarize, ARD clearly deserves an above average forward P/E multiple for 2007. Oil will base and move higher in Fy2007. Keep in mind that the earnings power of ARD in 2007 is greater than the Wallstreet estimate of $2.81. (We will discuss the issue of ARD earnings potential and share price in a future post.) In reality ARD is undervalued today by an amount that is significantly greater than 25%.


GMXR deserves at best the average forward P/E of the peer group and probably a lower one. I am confident that analysts are again over-estimating GMXR earnings capability just like they did in FY2006. Winters are not as cold as they used to be...global warming. This translates into less NG requirements. Also with the advent of LNG shipments, there will be no shortages in the USA. Prices will remain in check for natural gas. Since I feel GMXR earnings estimates from Wallstreet are overstated I feel the depreciation potential today of the GMXR shares exceeds 22.1%.

ARD will grow earnings significantly faster than GMXR. ARD share price will also grow significantly faster than that of GMXR. Since GMXR shares are currently OVERVALUED expect GMXR shares to be lower in FY2007. An investment in GMXR at current prices will go down in value over the next 12 months (barring an unusually cold winter and multiple hurricanes in the GOM in summer 2007.)

The bottom line is this: Sell GMXR. Buy ARD. Do it while GMXR share price is above that of ARD. GMXR shareholders have a GOLDEN OPPORTUNITY to profit from jumping from the OVERVALUED GMXR "ship" to the UNDERVALUED ARD "ship."

My track record of recognizing "sinking ships" and "rising ships" is perfect. God has blessed me with an ability to evaluate companies and make good decisions based on the information.

The choice is yours: Stay on the GMXR ship (Titanic) and go down with the ship to the low $30s (or lower)

-OR-

Put on your lifejacket and jump in the lifeboat (ARD) that will not only preserve your wealth (capital preservation) but also increase it significantly from present levels.

FPA Fund Letter to Shareholders
Read the discussion on Energy

ARD Limit Order Filled @ $41.75
Undervaluation Continues to Drive Share Acquisition Program

This order was filled on Tuesday morning. While it would have been nice to have had an order filled on Friday morning when the shares dipped momentarily below $40, I am satisfied with my latest entry point at $41.75. The shares could drift below $41.75 short-term. Long-term these shares are undervalued significantly as indicated in my November 17, 2006 blogpost. I continue to put my money where my mouth is.

Arena Resources #24 on IBD 100 List
Report in November 20th Edition

Investors Business Daily is a publication that emphasizes trading based on technicals along with a whole host of "trading rules" that can only be characterized as bad advice. For this reason, one should discount the value of the information between the pages. However, due to the fact that the IBD 100 List is a source of ideas for many investors (both retail and institutional) one can not discount the value of being listed #24 on the list. Effectively Arena Resources is getting free advertising for the company and the shares. This fact will put ARD on the radar screen of more investors every day.

ARD Shares Are Currently Undervalued
Benchmarking Indicates Significant Undervaluation

Benchmarking ARD Production Growth, Earnings per Share Growth, EBIT Margin and 2007 Forward P/E with the Domestic Oil Producer Peer Group Indicates Significant Undervaluation. ARD production and earnings growth for the first 9 months of 2006 is leading the entire peer group. (Click here to learn how the peer group was selected.) ARD also has an EBIT margin that is tops among the peer group. Given the fact that ARD has outperformed the peer group both past and present in addition to a future that is every bit as bright as any company within the peer group it is amazing that ARD has a 2007 forward P/E ratio that is below the peer group average. Based on future growth prospects ARD probably has one of the brightest if not the brightest outlook. Therefore, ARD shares are without a doubt undervalued in relation to the peer group.

The charts below indicate ARD with the blue bar. The average of the peer group is indicated by the red bar. Chart one below depicts ARD production growth of oil and gas exceeding every company within the peer group. In fact ARD oil and gas production is nearly 3 times greater than the average.


Chart 1 (Click on image to enlarge)

Chart 2 below indicates that ARD superior oil and gas production is driving superior earnings per share. It is interesting to note that not only is ARD leading the peer group in terms of EPS growth YoY but the ARD growth rate is over 3.5X that of the peer group average.


Chart 2 (Click on image to enlarge)

Below in Chart 3 we find that ARD is also the leader in EBIT margin. EBIT margin is defined as earnings before income taxes as a percentage of revenues. The fact that ARD is a leader in EBIT margin also indicates that ARD has an extremely low cost structure. Businesses with a higher margin and lower cost structure than their peers deserve a valuation premium. It is amazing how ARD exceeds the company with the second best EBIT margin by a whopping 53%. ARD's EBIT margin is nearly double that of the peer group average. This is truly amazing.


Chart 3 (Click on image to enlarge)

Given the facts above, it is most amazing that ARD superior performance, fundamentals and future prospects are overlooked by virtue of ARD having a below average 2007 forward P/E as indicated in chart 4 below. It is interesting to note that the peer group average 2007 forward P/E is actually 31% higher than that of ARD.


Chart 4 (Click on image to enlarge)


Golden Opportunity

ARD Shares present investors with a golden opportunity to own shares of a superior company at a significant discount to the market. This discount not only provides enhanced share price appreciation potential but also increased margin of safety. With tremendous growth in production and ultimately earnings per share in concert with an increasing 2007 forward PE multiple as the market recognizes the current excessive discount in relation to Arena's peers, these shares are poised for explosive upside potential. In other words, ARD share price will explode to the upside based on growth in earnings as well as P/E multiple expansion. Always remember that the three most important drivers of share price appreciation are (in no particular order): Earnings, Earnings and Earnings.

ARD Closes at Record High of $41.99
All-Time High of $42.39 set Intra-Day

ARD Q3'06 10Q Released Promptly After Friday's Market Close
Quarterly Report Hit the Wire Promptly at 4:17pm EST

Here were my estimates:
Revenues: $17.9 million........ (up from $14.69 mm in Q2'06)
Net Profit Margin: 42%......... (down from 43.8% in Q2'06.)
Net Income: $7.51 million.....(up from $6.44 mm in Q2'06.)
Share Count*: 15 million.......(up from 14.71mm in Q2'06.)*
(Fully diluted)
EPS: $0.50.......(Up from $0.44 in Q2'06/ $0.27 in Q3'05.)

Here are the actual results (with sequential quarter and Year over Year changes):
Production: 302,512...........(up 25.4% QoQ).......(up 114% YoY)
Revenues: $18,192,860.......(up 23.8% Q0Q).......(up 129% YoY)
Net Profit Margin: 44%.........(up 0.4% QoQ).........(up 1.6% YoY)
Net Income: $8,006,824.......(up 24.2% QoQ).......(up 132% YoY)
Share Count*: 15,579,742......(up 5.8% QoQ).........(up 20% YoY)
*(Fully diluted)
EPS: $0.51.........................(up 15.9% QoQ).......(up 88% YoY)

ARD topped my estimates across the board with the exception of the share count. Production was 7,500 barrels higher than the estimate in the Q3 operational update. This lead to higher than estimated revenues. The lack of "other expenses" and the addition of "interest income" helped increase the estimated net profit margin from 42% to the actual 44% (previous quarter net margin was 43.8%.) Even with the higher than estimated share count earnings still topped my estimate of $0.50 by a penny. The analyst consensus estimate was for $0.47. ARD matched the high estimate of those polled. Q3'06 was undoubtedly a superb quarter from top to bottom.


Based on current share price of $36.68 and the Q3'06 earnings the current trailing 12 month P/E has been lowered to 25 (ttm earnings have risen from $1.17 to the current $1.44.) This is historically low. ARD ttm P/E normally trades between a range of 30 and 45. Even if investors awarded ARD shares a ttm P/E of 30 that would generate a share price of $43.20. This is a 17% premium to Friday's close.

Given the fact that other companies with lesser future expectations and fundamentals are awarded higher forward P/E multiples it should be evident that ARD is positioned to rally so as to have a forward P/E at least inline with the other inferior companies. Some companies that have higher forward P/E ratios are as follows (along with their forward P/E.)
1. DPTR................295
2. CWEI...............44.4
3. UPL.................25.6
4. GMXR...............22.8
5. PLLL................17.7
6. DNR.................15.7
7. TXCO...............15.5
8. PXP..................14.5
9. ARD................13.1

Six of the companies listed above (not including ARD) have been written about extensively in this blog. In fact detailed analysis of production growth, EBIT per BOE produced, Cost per BOE produced, operating margin and others all indicate that ARD is the superior company across the board. Therefore, it is amazing that the 6 companies studied with inferior fundamentals and future prospects are awarded a higher forward P/E multiple. Over time one should expect the market to make the necessary corrections so as to award ARD (the superior company) with the higher forward P/E ratio. This is further proof that ARD shares provide investors with significant value, margin of safety and tremendous upside potential.

Delta Petroleum (DPTR) vs ARD
Which Company Offers Superior Future Prospects?

Today I recieved a request from Mrdecember123 to provide analysis on which company has the better future prospects and investment potential. An email was sent to Mrdecember. The contents of that email are as follows:

Dear Mr December,
I"m not sure if this is an email account that you check. Hopefully it is. While we have had our differences in the past we'll have to agree to disagree on our investment philosophies and what makes a good investment. In any case, I respect you as a person. I"m sure the feeling is mutual. I spent an hour today to fulfill your request of comparing DPTR and ARD. The information I"m providing to you is at no charge. :-)

Delta Petroleum (DPTR) has proved reserves of 44,901,000 BOE. Of this amount 32% is oil. DPTR has a hedge in place for 300,000 Bbl of oil in 2006. This amount would represent 28.4% of 2006 oil production if year over year production is flat. The ceiling on the hedge is $61.80 with a floor of $35. Clearly the hedge provides no downside protection as oil will never go below $35 in 2006 but limits upside of rising oil prices to $61.80. No doubt the hedge will impact a significant portion of their 2006 production. One should certainly expect oil prices to rise above $62 a barrel before the hedge expires (June 2007) due to winter heating season, peak oil, geopolitics (most noteable Iran) and terrorism.

DPTR has offshore production operations on the Gulf Coast. Even though it is for a small portion of their total oil production it increases the cost structure in total, increases risk of instability in oil production, and reduces predictability of production, revenues, net income and EPS during the hurricane season. Investors pay a premium only for those companies that can demonstrate predictability and transparency in these factors.

As of the 2005 10K DPTR had 4.32 Mcf gas and 0.35 BOE oil per share. Based on $8/Mcf and $60/Bbl oil DPTR has oil assets per share of $55.56. In 2005 DPTR had a net profit margin of 15% (the latest quarter net margin was only 9%.) If the entire proved reserve base were extracted in 2005 with the 15% profit margin net income would amount to $8.33 per share. The math is as follows:
$55.56 (oil assets) X 0.15 (net profit margin) = $8.33

This current share price of $25.34 represents over 3X the oil assets value per share. In other words, you are paying $25.34 to achieve $8.33 in value. This is not an acceptable business proposition.

IN Contrast...

ARD had 1.97 Bbl oil per share and 2.52 Mcf gas per share as per the latest 2005 10K. The company also had shares outstanding of 12,614,244 as of the 10K filing date. Based on $8/mcf and $60/Bbl oil ARD had oil assets per share of $138. ARD had a net profit margin of 36.6% in 2005. If ARD proved reserves were extracted in 2005 oil assets per share would have been valued at $50.50. Math is as follows:
$138 (oil assets) X 0.366 (net profit margin) = $50.50

The value of the oil assets represents a PREMIUM of 44% over the current share price of $35. This is an excellent business proposition.

ARD shareholders should expect proved reserves to increase in 2006 even though there were no acquisitions. How is this possible? In 2006 ARD will drill 120-130 wells. Of these wells 107-110 will be value creators. In other words, the 107-110 new wells drilled will create 139-140 new PUDs. (For every well drilled 1.25 new PUDs are created.) Essentially, 139-140 new PUDs will be created as a result of the 2006 drilling program. Each well on the current 20 acre spacing is estimated to have reserve potential of 45,000 Bbl. Simple math reveals the following:

140 (new PUDs) X 45,000 Bbl (proved reserves potential) = 6.3 million Bbl proved reserves.

The 2006 drilling program could easily add another 6.3 million Bbl oil proved reserves without any acquisitions. This doesn't even take into account increases in proved reserves due to the natural gas drilling program. In 2005 the natural gas proved reserves more than tripled from the previous year when gas proved reserves increased from 1.66 MMBOE to 5.33 MMBOE. This occurred in the absence of any major acquisitions.

Fundamentally, ARD has the lowest cost structure of any domestic oil producer. ARD also has the highest operating margins, net profit margins, and production growth. Additionally, ARD is unhedged, debt free and has a $150 million line of credit. This company is well positioned to continue an aggressive drilling program and/or make smart acquisitions in 2007. Proved reserves will continue to grow in 2007 without a doubt. On top of all this ARD management is second to none. CEO Tim Rochford and Chairman Stan McCabe are extremely talented individuals.

Here is the kicker: ARD is currently in the early stages of exploration on their Syracuse property in southwest Kansas. They are drilling to a depth of over 5000'+ to the St.Louis formation. The St.Louis formation is predominately oil bearing. According to CEO Tim Rochford the St. Louis formation has, "...very large reserve potential." Expect 1-3 wells to be drilled in the 4th quarter to reach the St.Louis.

Currently there is no better investment in the oil sector than Arena Resources (ARD.)

Sincerely,
Dok

ARD Limit Order Filled @ $34.86
Expect Excellent Q3 Results Friday After the Close

Many wanting to find an entry point before final Q3'06 results are released after the market close on friday (10Q should be posted at this time) will be looking for the right opportunity between now and then.

Without a Doubt ARD is Undervalued

ARD is trading with a P/E ratio of 29 on ttm earnings of $1.18. Factor in expected Q3 results of $0.50 and the ttm earnings increase to $1.40 along with a P/E ratio of only 24. That is a bargain considering that ARD is the leader in terms of low cost structure, high operating margin, net profit margin, production growth, EBIT per BOE produced, cost per BOE produced with a superior balance sheet. The management team is second to none. Look for the company to impress after the close on Friday. Also look for the company to impress on Monday with the conference call. The key will be the results of any 5400'+ wells drilled in Kansas to the St.Louis formation. The results could be exciting. Hopefully there will be at least one successful completion to the oil bearing St.Louis formation.

ARD Q3 Conference Call Scheduled for Monday, November 6 at 10 a.m. CST
This Company is Extremely Transparent and Predictable: A Good Thing

On October 27, 2006 I posted, "(Don't be surprised if the company 10Q is released after the close of trading on Friday, November 3 with the third quarter conference call to be scheduled promptly at 10 a.m.CT on Monday, November 6.)"

Today (November 1, 2006) Arena Resources made it official: ARD Q3 Conference Call scheduled for Monday, November 6 at 10 a.m. CST.

While I have no insider information I must admit that the company is very transparent and predictable. Five days before the official announcement was made I correctly predicted the exact day and hour of the earnings press release and conference call. (Keep in mind that even thought the company indicates that a press release will be issued the morning of Monday, November 6th, the 10Q will actually be posted after the market close on Friday, November 3rd.)

Stan McCabe's share sale was an indication that Q3 final results will be excellent. Due to my suspicion of the final results being excellent (Stan's share sale) the only logical day to have the Q3 final results and C.C. was on a Monday. That way investors (both retail and institutional) have all week to savor the data and drive the share price higher. The fact that the Q3 press release and conference call are scheduled on a Monday is confirmation that the numbers will be real good.

What can we expect for Q3'06 earnings?
Revenues: $17.9 million........ (up from $14.69 mm in Q2'06)
Net Profit Margin: 42%......... (down from 43.8% in Q2'06.)
Net Income: $7.51 million.....(up from $6.44 mm in Q2'06.)
Share Count*: 15 million.......(up from 14.64mm in Q2'06.)*
(Fully diluted)
EPS: $0.50.......(Up from $0.44 in Q2'06/ $0.27 in Q3'05.)