Summary
- The substantial sell-off in oil has created a route in small-cap oil stocks.
- The market is rightfully concerned with companies with very high relative debt levels. Some of these companies may wind up in bankruptcy if oil stays in the $50 price range.
- The sell-off has created an opportunity to find small-cap oil stocks with relatively low debt levels that will survive and ultimately thrive in the current environment. Five are presented here.
The old saying is the time to buy is when there is blood in the streets. There is plenty of carnage in small-cap oil and gas stocks due to the price of oil dropping from over $100 in July of 2014, to under $50 in January of 2015. Many stocks have declined by 50% to 80% from their July highs. Wall Street loaded lots of small-cap oil stocks with debts that they may not be able to pay back if oil prices stay below the $75 range for an extended period of time. The market is rightfully concerned about potential companies becoming bankruptcy candidates, especially if conditions in the oil markets do not improve.
Many management teams decided to follow the model employed by Brigham Exploration in the Bakken. Brigham drilled the first highly successful Bakken wells in far western North Dakota in Williams and McKenzie counties. The small operator then took on large amounts of debt to acquire as much acreage in the area and drill as many wells as it could. The plan was to build an asset base large enough to provide economies of scale to a large oil and gas company. Brigham succeeded when Statoil (NYSE:STO) paid $36 per share in cash to acquire the company. Kodiak employed the same model with loads of high-priced debt and was recently acquired by Whiting Petroleum (NYSE:WLL) in a deal Whiting should have walked away from.
Those days are over, and the management teams that followed that business model may have made a big mistake. It doesn't matter how good of an operator a company is, if most of their acreage that was very profitable when oil was over $100 is now uneconomic when oil is under $50. In researching this article it was amazing how easy it was to find small-cap oil and gas companies with high debt loads, and how relatively difficult it was to find similar companies with relatively low debt loads. A company's debt load is being compared to their revenues, and to their total shareholder equity versus total liabilities. Now, it should be noted that all of these companies have some cash and receivables to offset some of their liabilities. But in almost all cases it is just a small fraction of the bigger picture. All of the comparisons in this article come from a company's 2014 third quarter 10-Q filings with the SEC. Investors need to note that all of the companies presented are anticipated to have sharp downturns in quarterly revenues from the third quarter. Almost all of these companies will also wind up with asset write-downs if low oil prices persist.
To get a feel for how relatively low the debt levels are for the five stocks to be presented, we will first look at a sample of five companies with relatively high debt loads.
Oasis Petroleum (NYSE:OAS) is another company whose third quarter financials present a relatively high debt load. The company had total liabilities in the third quarter of $3,272 million versus shareholder equity of only $1,520 million. That represents a high 2 to 1 debt to equity ratio. The company had third quarter revenues of $350 million. On an annualized basis revenues would come out to $1,400 million. The company's debt is more than 2 times its annual revenue. While Oasis is a very good operator, it looks like they have taken on the high debt strategy at the wrong time.
Sanchez Energy (NYSE:SN) has a relatively high debt load according to theirthird quarter financials. The company had total liabilities of $2,026 million versus shareholder equity of $1,079. That is almost a 2 to 1 debt to equity ratio. Their third quarter revenues were $207 million. When annualized, their third quarter revenues come out to $827 million. The company's debt is almost 2 1/2 times its annualized revenues, and that is before the collapse of oil prices in the fourth quarter. Sanchez has taken the Brigham model to heart and has been aggressively growing the company.
Triangle Petroleum (NYSEMKT:TPLM) is yet another company whose third quarter financials show a relatively high debt load. The company had total liabilities of $1,015 million versus $536 million in shareholder equity for a relatively high debt to equity ratio of 2 to 1. The company also had $174 million in third quarter revenue. But $94 million was from oil field services, both for the company's benefit and from third parties. That revenue will go away if the company and others wind up laying down multiple rigs. Only $80 million was from oil and gas sales. Annualizing the $80 million in the third quarter leads to $320 million in oil and gas revenue for a very high 3 to 1 debt to revenue ratio. Triangle desperately needs for oil prices to rebound strongly sometime in 2015.
Goodrich Petroleum (NYSE:GDP) also has a relatively high debt load according to their third quarter financials filed with the SEC. The company had $798 million in liabilities versus just $215 million in shareholder equity. Their debt to equity ratio is almost 4 to 1. The company had third quarter revenues of $55 million, which on an annualized basis is $220 million. Their debt is almost 4 times higher than their revenue. Goodrich made a bold play to be the leader in discovering the Tuscaloosa Marine Shale in Louisiana and Mississippi. They had success, but the wells are very expensive and unfortunately are uneconomic in the current energy commodity price structure.
Investors in oil and gas companies with relatively high debt levels need to understand that these are speculative investments betting on a sharp turn around in oil prices over the next year. Perhaps a better way to invest in the sector for an anticipated eventual recovery in oil prices is to find companies with low debt levels that can wait out the downturn. Here are five small-cap oil and gas companies with relatively low debt levels compared to their shareholder equity, and compared to their revenues.
Matador Resources (NYSE:MTDR) is an example of a company with a relatively low debt in the industry versus its revenues and shareholders' equity according to its SEC third quarter financial statements. Matador had total liabilities of $459 million, but the company had shareholder equity of $818 million. Matador had approximately a 1 to 2 debt to shareholder equity ratio. Additionally, the company had third quarter revenues of $97 million, which on an annualized basis totals $388 million. The company had around a 1 to 1 ratio of its debt compared to the amount of its annualized revenue. Of course, just the like the companies with high debt loads, the companies with lower relative debt levels are also now receiving much less for their oil and gas than they did in the third quarter. Matador has some very good acreage in the Permian, and the Eagle Ford, and is a well-managed operator. Investors interested in Matador can start their due diligence by reading a good Seeking Alpha research article on Matador by David Rulli.
Here is an overview for Matador Resources:
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Callon Petroleum (NYSE:CPE) is another relatively low debt small-cap oil and gas company when analyzing its third quarter financials. Callon has $176 million in total liabilities versus $415 million in shareholders' equity. This represents a very strong ratio of $1 in debt for every $3 in equity. The company had third quarter revenues of $40 million, which annualizes to $160 million. This is also an almost 1 to 1 debt to revenue ratio. Callon is a pure play Permian operator. Investors can start their due diligence on Callon by reading the following Seeking Alpha research article on Callon by Bret Jensen.
Here is an overview for Callon Petroleum:
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Contango (NYSEMKT:MCF) has a very strong balance sheet with a relatively low debt level based on its third quarter financial statements. The company has $277 million in total liabilities versus shareholder equity of $595 million. Contango has a 1 to 2 debt to equity ratio. The company had $67 million in third quarter revenue, which on an annualized basis would total $268 million. Contango also has an almost 1 to 1 debt to revenue ratio. This company is a diversified off-shore natural gas and on-shore oil resource play with acreage in the Woodbine, Eagle Ford, and Buda. A very extensive Seeking Alpha research article on Contango was written by Small-Cap Capital.
Here is an overview of Contango:
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U.S. Energy (NASDAQ:USEG) also has a very strong balance sheet according to their third quarter financials. The company had $16 million in total liabilities versus $110 million in shareholders' equity. That makes the company's debt to equity ratio almost 1 to 7. In the third quarter, U.S. Energy had $10 million in revenue. On an annualized basis the company would have $40 million in revenue. That provides a debt to revenue ratio of approximately 1 time debt to 3 times revenue. U.S. Energy has assets in the Bakken, and the Eagle Ford. They also have a new President converting the company from a non-operator to an operator model. A very good Seeking Alpha research article on U.S. Energy was written by Hawkinvest.
Here is an overview of U.S. Energy:
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Abraxas (NASDAQ:AXAS) has a relatively low debt level according to its third quarter financials. The company had total liabilities of $141 million and total shareholders' equity of $176 million. This provides a very good debt to equity ratio of less than 1 to 1. The company had third quarter revenues totaling $44 million. On an annualized basis, revenue would coincidently also be $176 million. Again, the debt to revenue ratio would also be a very good less than 1 debt to 1 times revenue. Abraxas has assets in the Bakken, and the Eagle Ford, and is a well-run company. A Seeking Alpha research article on Abraxashas been written by Investorcrunch and investors can use it as a starting point for their own due diligence.
Here is an overview of Abraxas:
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The oil markets have been very volatile and could go lower, or catch everyone off guard and shoot higher. After all, almost all investors were caught off guard by the steep plunge in oil prices at a time when the S&P 500 continued to hover near record highs. Investors wanting to own oil stocks for a potential rebound should consider switching out of companies with relatively high debt loads and into companies with relatively low debt levels. Investors who are unsure if oil prices will rebound in the next few years should completely avoid this sector, including all of the stocks mentioned above.
Everyone should do their own due diligence before investing in any company. The information here, links to research articles, and especially the links to SEC quarterly filings, are intended only to provide a starting point for investors. While a real opportunity awaits if oil prices rebound, unless one can time it perfectly, its best to focus on companies that can wait out the slump and come out on the other side.
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