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5 little-guy oil sector winners
These companies are posting bigger earnings gains than some of their larger competitors because less can mean more to their bottom lines.
By Jim Jubak
Most of the time it pays to buy shares of the biggest, lowest cost producers. It's these companies that'll wring bigger profits out of every sale and gradually take market share from less-efficient competitors.
But this clearly isnt most of the time for oil stocks. Shares of small exploration and production companies, largely drilling in the United States and producing oil and gas at relatively high costs, are leaving shares of the industrys most efficient producer, ExxonMobil (XOM, news, msgs), in the dust.
Just compare the one-year price chart for ExxonMobil to Swift Energy's (SFY, news, msgs). Since August, the smaller producer's shares have opened up an increasingly wide gap with ExxonMobil's stock.
I dont expect this gap to narrow soon. In fact, its likely to increase over the next six to nine months as long as the price of oil stays over $35 a barrel.
Why is the race going to the sector's Swift Energys rather than ExxonMobil and its huge peers?
A big impact
Read any quarterly report from one of these small production and exploration companies and the answer leaps out at you: They're drilling as fast as they can get a bit through rock, and at their size, an additional hundred wells pumping in a quarter has a tremendous effect on the bottom line.
For example, Swift Energy drilled 41 new wells in the year's first nine months, according to its third-quarter report. All that extra activity added 915,000 barrels of oil to the companys production. For a behemoth like ExxonMobil that pumps about 2.6 million barrels of oil a day, thats a drop in the bucket. ExxonMobil grew oil production by 1.8 million barrels in the second quarter, or just a 1% production increase. For Swift Energy, however, the 915,000 extra barrels was a 35% production increase.
Now watch how the leverage works as the companys costs are spread over more barrels at the same time that the price of oil is rising. The 35% increase in production turns into a 101% increase in net income during the year's first nine months.
No wonder that Wall Street analysts are looking for Swift Energy to grow earnings per share by 98% this year, well above the spectacular 42% growth projected for ExxonMobil.
Swift Energy isnt the only small oil and gas producer racing ahead of the big boys.
Ive found three stocks of small oil and gas producers that'll outperform shares of the majors over the next six to nine months. Each gets a 9 or 10 from our StockScouter, out of a possible 10, a notch higher than the 8 that ExxonMobil earns. All have market capitalizations significantly smaller than ExxonMobils $330 billion.
Upgrading earnings
Swift Energy operates just over 1,000 wells in Texas, Louisiana, and New Zealand. Oil makes up about 47% of the companys proved reserves (with the rest natural gas). Louisiana accounts of 40% of proven reserves, Texas 37% and New Zealand 21%.
Besides the 41 new wells that I noted above, the company has begun an upgrade of its production platforms, adding new pumps and compressors and installing a new delivery system. High oil prices have also made it worthwhile for the company to collect new seismic data in its Lake Washington production area. It looks like Lake Washington will support even higher production in 2005. But the companys ability to pump it will depend on the completion of those upgrades. This year's capital expenditures could wind up as much as 25% higher than in 2003.
Boosting production
St. Mary Land & Exploration (SM, news, msgs) is in the midst of an even more expansive program to increase production than Swift Energy.
During the year's first nine months, the company drilled 110 new conventional wells, with a 90% success rate. In addition, the company participated in the drilling of 66 wells to extract methane gas from coal beds.
The company also has been acquiring new production properties. For example, St. Mary recently paid $98 million in cash in three transactions that added 70 billion cubic feet equivalent of gas and oil in proven reserves, which is equal to about 10% of the companys proven reserves at the end of 2003. This shows what a company with positive cash flow can do. St. Mary grew cash flow from operations to $157 million in the third quarter from $151 million a year earlier.
It's using a chunk of that cash flow to pay down debt and buy back shares. Because Wall Street still believes oil and natural gas prices will fall next year, most production and exploration companies will see slowing growth, according to analysts. But St. Mary is one of the few oil companies pegged to show earnings growth in 2005 from this year's levels. The consensus projection is for 15% earnings per share growth next year.
More than oil
Penn Virginia (PVA, news, msgs) has about half the proven reserves of St. Mary, mostly along the Gulf Coast and the eastern United States. This hasnt been a great year for Gulf Coast oil production thanks to a long hurricane season and some pipeline problems in the East. Third-quarter production was up only slightly from 2003. But total revenue still climbed 22% in the year's first nine months, and the company expects production to pick up in the fourth quarter and into 2005.
With Penn Virginia, investors also get major coal exposure since the company owns Penn Virginia Resource GP, which serves as the general partner in Penn Virginia Resource Partners (PVR, news, msgs), a limited partnership that owns the coal assets spun off by Penn Virginia in 2001. Penn Virginias coal royalties grew 47% in the third quarter from a year earlier. (The company also owns about 166 million board feet of standing red and white oak, yellow popular and black cherry saw timber.) The Wall Street consensus projects earnings per share will grow by 40% in 2004 and 17% in 2005.
As Penn Virginia illustrates, not all small production and exploration companies are alike, and the difference in their asset bases gives individual stocks strikingly different exposure to the ever-shifting global energy situation.
In my two exclusive picks for CNBC.com on MSN readers Ive picked companies that demonstrate just how wide that spread can be.
Risk seeking reward
Harvest Natural Resources (HNR, news, msgs) could be the most volatile stock in this group on market cap alone because it's the smallest among these five stocks at $640 million. Then there's the fact that Harvest operates far from the relatively staid and established fields of the United States. It's producing oil from its South Monagas field in Venezuela, not exactly a model of political stability these days even among oil-producing countries. Its proven reserves in Venezuela come to about 100 million barrels of oil equivalent.
Youre also not exactly buying a history of stable management. The entire board was replaced in 2000 and new management was brought in during 2001. But that history gives the stock its speculative edge.
Youre betting that Venezuela will be relatively stable, or at least stable enough so the company can get its oil and gas out. And youre betting that the new management team will bring order to the company.
On that second issue at least, the stock looks promising. The new CEO, Peter Hill, is a 22-year veteran of BP (BP, news, msgs). The company has completed a gas pipeline that will add revenues from a transmission business to the company coffers. Management has hedged a significant portion of its Venezuela production for 2005 at $42 a barrel. And Harvest has sold its Russian interests, removing it from the political turmoil that envelops that countrys oil sector. Wall Street projects 360% earnings growth for 2004 and 46% for 2005.
Too conservative?
Denbury Resources (DNR, news, msgs), on the other hand, has suffered this year from being too conservative.
The company hedged oil and gas to protect itself against price declines, but those hedges wound up costing it $55 million in the year's first nine months. Thats a significant chunk of change when the period's revenue was $284 million, according to Standard & Poors. Denbury anticipates that the cost of these hedges will rise in the fourth quarter from the third quarters $22 million and then drop in 2005 as most expire. This should enable the companys solid growth story to emerge.
Without acquisitions, Denbury projects 10% organic production growth next year, which would give it one of the most stable two-year earnings growth patterns in the oil production sector. Earnings per share will grow 26% in 2004, and 26% in 2005, the consensus projects. Key to the companys growth is its ownership of sources of carbon dioxide and pipelines in Mississippi and Louisiana that let it apply advanced recovery techniques to get more oil from fields other companies have labeled exhausted. At the beginning of March 2004, Texas Pacific Group, a private investment group known for taking companies private, held 17% of Denbury. (Texas Pacific Group sold 7.2 million shares that month at $15.02. I guess even big investors can get impatient.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak didn't own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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