This Energy Company Is Deeply Undervalued

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

Kodiak Oil & Gas (NYSE: KOG) is a fast growing oil production company. It has seen its oil production increase from roughly 4,000 barrels of oil per day to almost 16,000 barrels of oil per day in the third quarter of 2012. Operating Income increased over 200% this past quarter. The stock is trading around $9 per share with a ratio approaching 37. Debt is the main concern going forward. But it is not unusual for a small fast growing energy company to shoulder a large debt load. Kodiak is primed to pay off for the smart investor who knows that debt is just one factor of many in evaluating the future of a company.

Kodiak is a major player in the Bakken oil play. The area is producing 700,000 barrels of oil per day and this will increase to over a million barrels of oil per day as crude prices rise and global demand continues its steady increase. Kodiak is seeing almost all its revenue coming from oil production, so its involvement in this play will drive this company going forward. The company has roughly 800 wells in the Bakken with seven rigs. Producing oil in the region has required a great deal of capital expenditures which has grown the company's debt.

Despite the high growth the company has experienced so far in 2012, the stock price has not moved very much from where it was last year. One reason for that is investor fear that the small company cannot handle oil price swings in the way larger Bakken play competitors like Continental Resources (NYSE: CLR) are able to do so. Continental Resources recently announced that it will acquire several Bakken properties for $650 million through an agreement. The properties are located primarily in Divide and Williams counties in North Dakota.

But it must be remembered that much of the company's acreage is, as of yet, undeveloped. The proven reserves in the Bakken cannot be ignored, and this company is poised to see tremendous profit. Even if oil prices show further decline, hedging strategies can absorb the brunt of a downturn for several years. Further, with those proven reserves, the absolute worst case scenario is a takeover with a 10%+ premium on the current price. It is one of the easiest low-risk high potential stocks on the market.

There are companies involved in Bakken production that are not burdened by the high debt that Kodiak has. Triangle Petroleum (NYSEMKT: TPLM) is a good example. Triangle has a fraction of the debt that Kodiak carries, so is it a better buy? Triangle has upside, but it is dwarfed by the upside in Kodiak. Kodiak carries far more acreage in the Bakken, and its total reserves those of Triangle. For investors who want to see their investment really take-off, Kodiak is a superior choice, and no one should let the debt load of the company lead to a no buy.

Kodiak is not burdened with heavy investment in natural gas, another positive for the company going forward. Exxon Mobil (XOM), the country's leading natural gas supplier, has seen its stock priced weighted down by the increase in natural gas inventory and decline it its price. Chesapeake Energy (CHK), the country's second largest producer of natural gas, has had to aggressively sell assets in order to pay down debt and increase cash flow due to the declining natural gas market. Kodiak has escaped these troubles because it is strictly an oil producer. Its focus has been entirely on increasing its production in the Bakken, and it has proven remarkably successful in doing so.

Kodiak has been very efficient. In the latest quarter, third quarter 2012, it saw a 29% decrease in lease operating expenses over the same quarter last year. A large part of this savings is attributed to better availability of trucking services. More importantly, the company has invested in water wells and water gathering facilities in an effort to cut costs dramatically. As these water gathering facilities come on line and are connected to wells, the company will see further cost savings.

Underscoring the potential Kodiak has the company saw 328% increase of oil and gas sales through the first 9 months of 2012 compared to the first 9 months of 2011, $277.8 million vs. $65 million. The Company reported net income for the nine-month period ended September 30 of $98.3 million, or $0.37 per basic and diluted share, compared with net income of $37.6 million, or $0.20 per basic and diluted share, for the same period in 2011. These are phenomenal growth numbers that are not fully recognized in the stock price. The reason is the debt the company has taken on in order to expand and produce the shale oil. The company has also taken a rather aggressive hedging approach to shield it from oil price swings, this has eaten into profits.

As the company goes forward, it will reduce its debt load while production continues to increase. As this happens, it will become clear that the company is grossly undervalued. The smart investor will recognize that value now and get in on this rising stock early. The company is currently trading at around $9 per share. As the company continues to capitalize on its proven Bakken resources that share price should double this year. The market cap is less than $2.5 billion, and that is going to grow substantially. The best days of Kodiak are yet to come.

Take a Deeper Look

Kodiak Oil & Gas is a dynamic growth story, but with great opportunities come great risks. Before you hitch your horse to this carriage let us help you with your due diligence. To see if Kodiak is currently a buy or sell, check out The Motley Fool’s new premium report, which comes with a year of timely updates and analysis.

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