Is Kodiak the Next Apache?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: An earlier version of this article made an erroneous reference to the CEO of Kodiak Oil & Gas. This error has since been corrected.

Kodiak Oil & Gas (NYSE: KOG) emerged from the second quarter stronger than ever, while the frantic drilling schedule the company maintained over the past few years begins to bear fruit. As it gains its footing, Kodiak’s sales volumes are surging. Its second quarter oil and gas sales reached $85.8 million, nearly a 300% increase above its second quarter 2011 sales, which totaled $22.1 million. At the same time, Kodiak is lowering its costs per barrel, leading to the possibility of margins higher than its current respectable 12 month net margin at 36.7%. 

 

A Stellar Second Quarter

Unlike other firms that are calling for a calm second half to 2012, Kodiak plans to continue its surge ahead. Its 2012 production guidance calls for the firm to end the year with an average 17,000 to 21,000 boe per day, a substantial increase over its second quarter daily average of 12,696 boe. Given that Kodiak ended 2011 with a mere 3,922 boe per day and has an estimated 817 net well locations on its 155,000 net acres, I think it should be more than possible for Kodiak to meet its goals and beat its peers’ numbers to close out 2012. 

Kodiak recently announced a $150 million increase in its credit revolver, which raised its borrowing base from $225 million to $375 million. Standard & Poor’s Ratings Services reacted quickly to cut Kodiak’s senior unsecured rating to CCC+, noting that should Kodiak default on its obligations creditors will see less than 10% recovery. However, the firm’s corporate credit rating from Standard & Poor’s remains at B.

Shortly after, Global Hunter Securities upgraded Kodiak from neutral to accumulate, raising its price target from $8.00 to $13.00 at the same time. I think that Global Hunter Securities’ future outlook for the stock is right on the mark; Kodiak’s 52 week high was $10.90, and that was before two consecutive quarters of exponential growth.

 

Looking for a Focus on Cost Reduction 

Beginning in late 2013, Kodiak will face a need for considerable capital outlay as the original five year leases on its 34,000 acres in Dunn County begin to reach the end of their terms, a consequence of Kodiak’s rapid expansion. If Kodiak’s margins per barrel do not continue to decrease and it does not keep up with its rapid growth curve, this could result in Kodiak using a greater proportion of its credit revolver at a time when it should be concentrating on reducing its debt to equity. Currently, Kodiak’s drilling and completion costs are ranging between $10.5 and $11 million per well in Dunn County, which is high for the area. 

Competitor Continental Resources (NYSE: CLR) is seeing similarly higher costs, with its operated wells averaging $9.2 million per well and non-operated wells averaging $11.3 million. Continental plans to continue to work with its service providers and supply chain to lower these costs, but for now the costs are sustainable as Continental is hitting record production numbers with year over year increases comparable to Kodiak’s. Competitor Northern Oil & Gas (NOG) saw an increase in average well costs this year like Kodiak, but its increase was considerably lower; its initial estimated cost for 2012 wells was $8.2 million per well, but it revised the estimate upward to $8.8 million per well in its second quarter earnings report

Competitor GMX Resources (NASDAQOTH: GMXRQ) is working on reducing its well costs on the Williston to $8.5 million per well, in part through using a new directional drilling company as “services have become more readily available.” This is also allowing GMX to reduce its spud to oil sales time by twenty days, to seventy days total. On its face this is positive, but to avoid bankruptcy before a turnaround or takeover GMX needs a better plan, as discussed further below. 

Another Kodiak rival, Occidental Petroleum (NYSE: OXY), which counts the Williston as its third most important area of operations after its Permian Basin and California activities, is content to wait until well costs on the Williston come down. President and CEO Stephen Chazen had less than diplomatic words for the third parties working on the play in his company’s second quarter conference call, pointing out that “the service companies are getting rich as pigs” on the Williston. Chazen indicated that as a result, Oxy will focus on the best and most efficient wells while improving its learning curve, keeping the play as a future asset rather than a current growth driver. Unfortunately, Kodiak does not have the same luxury, since all of its assets are located on the Williston.

 

Outlook

Kodiak is currently trading around $9 per share, with a price to book of 2.3 and a forward price to earnings of 8.7. Its debt to equity stands at 0.8, which is below the industry average of 1.1 but a concern for its size and actual assets, as was noted by Standard & Poors in its decision to lower Kodiak’s senior credit rating. GMX is trading around $1, with a price to book of 2.6 and debt to equity of 15.7, one of the worst for Williston operators. GMX’s assets are appreciable, and at its current price it could be an attractive target for a takeover, especially as the infrastructure around its holdings improves.

Northern is trading around $17 with a price to book of 2.1 and a forward price to earnings of 13.2, considerably more expensive than Kodiak thanks to a surge in its stock price after second quarter earnings. Its debt to equity is a respectable 0.4 as it financed its 225% three year average revenue growth without leaning heavily on its revolvers. Oxy is an even better deal, trading around $91 with a price to book of 1.9 and a forward price to earnings of 10.3. As a well established E&P stock, Oxy has negligible debt, with a debt to equity at just 0.2.

The strong second quarter shows that Kodiak is making the right moves to grow. Its debt to equity and extension of its credit revolver are matters of some concern, but tolerable for a company in Kodiak’s growth stage. I believe that as its assets are further developed, a rise in the stock price will be supported as this firm comes to the notice of private investors; if well results continue on the same track as past results, Kodiak could easily become the next Apache or Anadarko over the next five to ten years.


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