Summary

• Antero has some of the lowest F&D costs in the industry.

• It has some ugly but prudent financials.

• AR has 1.8 Tcfe (more than 10% of proved reserves) in hedges until 2020.

As a value investors, we generally like to look at disasters to find potential bargains and shale gas potentially fits that profile today. May be, time will tell. So far, I have taken positions on WPX Energy (NYSE:WPX) and Delphi Energy (NYSEARCA:DEE) as I like their current pricing and potential upside. I do not have any specific technical knowledge about the E&P field, so I am going to keep it at the big picture level. Now, let's take a closer look at Antero Resources (NYSE:AR) and go through the questions I routinely ask myself before I buy a stock.

Is it a company that I would like to hold?

Well, on that point, not really. I was not a big believer in shale gas in the first place but with the right pricing environment, I am always ready to change my mind, and it seems to be the occasion to do so. But definitely, this is not the beautiful business that I would like to hold forever, it will never be an Apple (NASDAQ:AAPL) or a Visa (NYSE:V).

Antero resources is an E&P company that holds around 400,000 acres in the Marcellus Shale and 150,000 acres in the Atica Shale, two of the low-cost shale plays in the U.S.

At the end of 2014, Antero Resources had 12.7 Tcfe of proven reserves. To put things in perspective, this is equivalent to six months natural gas consumption in the U.S.; total proven and probable reserves are more than 40 Tcfe or two years of U.S. consumption. So this is quite a big fish we have here.

Antero Resources plan is to go from the current production level of 1 Bcf/d to 4 Bcf/d in 2018. This is quite a large increase too. As we implied above, American annual consumption is around 25 Tcf and putting an additional Tcfe per year on the market is no small change for a single company. Hopefully, about one-eighth will be exported through Cove Point and Sabine Pass.

How much is it worth?

This point has always been a major problem for me as these companies do not produce steady cash flows and they use their own in-house ratios that confuse me most of the time; it seems that E&P companies always find an angle to present their company from a rosy perspective. If this point is not really specific to E&P companies, E&P corporate presentations have elevated this practice to a special kind of art.

The best guess we can take is how much is the EV/Reserves compared to other deals in the sector. For example, The CEO, Paul Rady was involved in Pennaco, which has been sold to Marathon Oil for $446 millions in 2000. They had 200 Bcfe of proven reserves and potential of 800 Bcfe. That was $2.23 per Mcfe of proven reserves for the same ratio of proven/probable reserves.

Given the 12.7 Tcfe proved reserves at the end of 2014, it would give us avalue of $28.3 billions for the E&P assets alone, to be compared with an EV of the company of $13 billions today. Before you jump down my throat, I know that the situation is different today but still, it gives an idea of how much this could be worth in a situation where a company had similar characteristics (same proven/probable reserves ratio, same CEO). Bottom line -- the less than 1$ per Mcfe paid seems cheap, but this is the case for many E&P players.

Let's now look at the value of the lease, how much are 550,000 acres in Marcellus/Utica worth? Again, a difficult question to answer as it depends on many factors. If we judge by some random transactions, here is what we find.

In 2014, American Energy (NYSE:NOA) bought 75,000 acres for $1.75 billion in Marcellus/Utica -- that's $23,000 per acre. Still in 2014, Southwestern Energy (NYSE:SWN) bought 413,000 acres for $5.4 billion in Marcellus/Utica from Chesapeake, that's $13,000 per acre.

At what price do we get Antero Resources acres? $10 billion/550,000 = $18,182 per acre which seems like an average price to pay. Now, all leases are not created equal, and Antero Resources acreage seems to be well positioned in the center of both Utica and Marcellus (see company presentation or map for further details). I certainly hope we are paying a fair price for a very good piece of rock here.

What are the risks of loss? What are the protections against these risks?

Prices: After a rosy trip in the corporate presentation, let's dig into why it might not be a good deal. As always, there are risks involved, but Antero Resources would not be the first company to fall should the price of related commodities remain at a this level of price. To restate, if this one falls, I think we will have other problems to worry about than our Antero Resources common stock. This for two reasons: It is a low-cost producer with a very good hedging program.

The hedging of the company is very good with 1.7 Tcfe hedged for 4.41 $/MMbtu (source: 2014 annual company report), it is more than 10% of its proved reserves. That said, if prices were to remain depressed, these hedges would not be sufficient to cover Antero expansion plans. Indeed, a planned 2018 production of 4 Bcf/day amounts to 1.5 Tcf/year, the equivalent of the whole hedging program.

Liquidity/cash flows: One of the big problem of all the E&P companies it their liquidity and Antero Resources is no exception to the rule. Its level of capex is quite high compared to similar sized peers with still $1.8 billion planned for 2015, despite a 41% cut compared to 2014. Given that their 2014 CFO was $1 billion, they will need to find additional financing, even if we take into account their hedges and 40% increase in production.

Recently, the company announced its intent to issue $750 million of bondsand $485 millions of shares in order to repay its credit facility. On the debt front, the company is relatively safe, or at least safer than most of the other E&P companies. It does not have repayment obligations before 2019.

On the liquidity front finally, in case of problems, the company could further monetize its assets as it started in 2014 with the IPO of Antero Midstream. It stills holds 69.7% of the asset, for a value of $2.7 billion.

Why might investors not like it?

To state the obvious, the price of commodities first and foremost. These could stay depressed for a while, they could go higher, or lower. Nobody knows, and if some people do, I am certainly not one of them.

But there are other reasons to dislike the company, aside from the common problems of E&P companies. From afar, the financials look uglier than its peers: low revenues, increasing debt, negative FCF. For the deep-value investors looking at ratios like P/B, the deal is a big "no-no" with a P/B of 2.5.

But what is the largest asset in an E&P company balance sheet? Their finding and development (F&D) costs. What makes these F&D capitalized costs lower for Antero Resources?

1. The costs capitalized on Antero Resources balance sheet are less than peer because they have lower overall F&D costs. Actually, it has some of the lowest F&D costs according to this Howard Weil study.

2. The costs are capitalized according to the "successful efforts method of accounting," meaning that unsuccessful costs get directly to the Income statement and not to the Balance sheet like in most E&P peers (full cost method).

Also, this company is a good repellent to any EBITDA ratio investor; the company has little EBITDA because it has little "E" to start with, it does not seem to be the objective right now, they are in the process of ramping up sales. Furthermore, as mentioned above, earnings include some items that are capitalized for other companies, so the comparison from an EBITDA perspective it not really fair. I have seen articles stating that Antero was risky because it has a high debt/EBITDA ratio. This is kind of nonsense as EBITDA has to be lower, and I think this sort of nonsense is a good opportunity. Of all the reasons to not buy the stock, and there are plenty of valid ones, this is one of the worst.

Is it the right price at the right time?

The final question, arguably the most important, is about the price of the stock. Currently, the market prices the E&P assets of Antero Resources at less than $10 billion, which appear quite cheap. The only problem is that there is no catalyst on the horizon, prices could stay depressed for ages, but this is the case for all E&P companies. Another related question I have: How will the market absorb this additional capacity? Because if a single E&P company can add 1 Tcf/year on the market within three years, we are potentially looking for more trouble down the road, and we must be convinced that the infrastructure in the U.S. will follow. All these factors make it difficult for me to be really enthusiastic about the company.

Now, at the current level of $38 per share, the company is interesting for people who are looking for a solid investment with little potential downside. The company sells for less than 1$ per Mcfe and if history can serve us as a guide here, and I am not sure it can, this is cheap. Furthermore, Antero Resources is a low-cost producer with prudent accounting practices, and the company is increasing its reserves rapidly, providing a floor for valuation. For the adventurous investors, there are more aggressive plays out there, but I see Antero Resources as a safe company in the E&P field and a good but small addition to my portfolio. For the investors interested in Antero resources, I think that Range Resources (NYSE:RRC) is another similar company in size and characteristics that could be interesting to consider.