GST A - Gastar Preferred "A"

[TedKord]

I like the preferred stock of Gastar (GST). They trade on the NYSE for with almost a year of dividends in arrears. The 8.625% trade at 20.5 and the 10.75% trade a little north of 22. Both are $25 par preferred. I’ll limit my discussion to the 8.625% for simplicity, but the story is basically the same for both.

 

On Jan 10, GST announced that they will make up the arreage on the preferred on Jan 31 for holders of record on Jan 20, so these will go ex- on Jan 18. On the 8.625% GST will pay $1.80. GST will pay the dividend of .18 per month going forward. It will reduce their borrowing base but for the intermediate term, that doesn’t mean anything. GST has plenty of liquidity.

 

GST is a pure play located in the STACK in Oklahoma. The STACK has become one of the most popular plays in the US after the Permian Basin. Last October, GST sold some non-core acreage for 70m and, more importantly, cut a development deal with a “large, private, global investment fund”. The agreement covers 60 wells in which the investor will pay 90% of the costs and only get 80% of the returns.  This, by itself, is good news, but what this does is revalues a lot of GST’s 100% owned drilling sites. Think of it this way: once they drill a well subject to the agreement, engineers will make estimates of what the well will eventually produce and move the asset into Proved Developed Producing reserves (PDP), which can then be borrowed against. The engineers will also look at the wells to the right and to the left of the well and say that those wells should have roughly the same characteristics as the drilled well, so then GST can move those reserves from inferred reserves to Proved Undeveloped (PUD). These actions allow for more liquidity and will have a higher NAV which is how energy investors will look at it.

 

After paying down the arrears the preferred will have about a 10% current return. GST has an 8.625% bond due in May, 2018 which trades near par. Assuming their drilling is successful, they will need to refinance that note next year. I see no reason why they wouldn’t try and refi the entire capital structure at the same time.

 

[DeepSouth]

I see the senior secureds trading around 98, a >10% YTW. Don't know why you'd buy the preferred over short dated secured paper with comparable yield

[TedKord]

The discounted $ price is the reason I prefer the preferred. The total value of the combined prf is 154m and the total LTD is 418m. They will refi the bond next year once the properties are proven. I think it is likely they do a larger refi and take out the prf at the same time. If so you get the 10% carry + 20% capital gain. The bond is the safer play. If oil prices collapse, you will be much better off in the bond. I guess I think that risk is limited due to the relatively short term until they try and refi. I may be wearing rose colored glasses. If they don't take out the prf, they will trade where they are or perhaps a little better on the back of better funding and you can just trade out. I think the main reason to buy the bond over the prf is greater liquidity. If you think there is a reasonable chance oil revisits the 30s this year, you probably shouldn't buy either.

 

[NoCalledStrikes]

Call me a cynic, but I think their motivation to resume payments on the preferred isn't to refinance but rather to be able to sell more preferreds again into the market.

[ValueMaven]

Why were these trading at $13 just in November? 

 

Has the $7 upward move changed your view of the risk-reward payoff at all?

 

Thanks,

VM

[TedKord]

On October 20, GST announced a transformative transaction with an unnamed investor, which I went over briefly in the initial post. It has generally been moving up since then. The prf goes ex- tomorrow, which is worth $1.80.  There is a limit as to how much you should pay. If it gets north of 23.75 (95% of par) after it goes ex- you're better off in the bond as Deepsouth suggested.