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Why is Drillsearch Limited so cheap?

Given the keen investor interest in the highly prospective Cooper Basin oil and gas region it is surprising that several of the explorers and producers appear to be selling so cheaply. One which has caught my eye is Drillsearch Limited (ASX: DLS).

Drillsearch is a fast growing company with big potential, capable management and a manageable debt position. Future earnings are also expected to benefit significantly from rising east coast gas prices.

At the current price of $1.59 per share Drillsearch trades at a forward price to earnings ratio of less than 10. In any other industry a company this cheap and with similar prospects would be quickly snapped up by hungry investors, so why not Drillsearch?

Industry average

Drillsearch’s share price reflects the typical low values of many oil and gas producers. Woodside Petroleum for instance had a p/e ratio of just 10 before a fall in 2013 earnings pushed it up to 17, while according to data from New York University the average p/e ratio for integrated oil and gas companies in the U.S. is 11.

This is a symptom of the economic cycles that oil producers are subject to, as well as the high capital expenditure and risk involved in achieving growth. However for Drillsearch this fails to take into account the company’s strong production growth and the forecast rise in gas prices, tied to east coast demand.

Long-term growth

So are investors worried that Drillsearch is not a sustainable long-term company?

Drillsearch is the country’s third largest on-shore oil producer behind Beach Energy Limited (ASX: BPT) and Santos Limited (ASX: STO) and has forecast between 3.0 – 3.3 million barrels of oil equivalent (mmobe) for the full year 2014. This gives the company a current reserve life of just 10 years, compared to Santos’ 27 years.

However Drillsearch has a strategy to change this with its focus on unconventional gas in the region and an on-going aim to uncover 2C (contingent) resources through exploration and appraisal drilling. Over the long-term this will drive higher production and reserves, the value of which will be compounded by expected rising gas prices.

Foolish takeaway

Despite the low price traditionally assigned to integrated oil and gas producers, Drillsearch falls outside the typical mould with several years of low risk production and reserves growth ahead of it. This suggests to me that the company could offer more value for investors than the market is currently giving it credit for.

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Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article.

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