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.