A Value Play in Oil E&P
Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
More often than not, companies that are secluded and ignored by the market are the ones that outperform the benchmark indices. It's an added bonus if the company is operating in a rapidly growing industry with ample internal growth prospects. I believe that Cobalt International (NYSE: CIE) fits the description perfectly and offers significant value at its current valuations.
A Crude Hotspot
Cobalt International is an oil E&P company that operates with hydrocarbon-rich assets in Angola, West Africa and the Gulf of Mexico. It owns 246 blocks in the latter region with around 1.4 million gross undeveloped acres, but its real growth lies in Angola. As of now, Cobalt International owns three blocks in Angola with over 5.6 million gross undeveloped acres.
The company began drilling back in 2009, but its crucial drilling results started coming only in 2011. Its management recently announced that these discoveries were better than expected, and will most likely exceed the cash flow estimates once oil production from the country begins. For the current year, Cobalt International is awaiting the drilling results of eight different wells.
In 2010, Angola was the second largest oil producing country in Africa and the eighth largest crude exporter in the world. As of now, the country produces 1.75 mbpd of crude, and the Angolan government is planning to increase its production to 2 mbpd by 2015.
According to latest estimates, Angola has the proven reserves of over 12.66 billion barrels of crude oil, which suggests that the production ramp-up is bottlenecked by production capacity. Naturally oil E&P companies can thrive by producing more crude oil. But that’s not all.
Why Cobalt International
These hydrocarbon rich reserves allow the production of high-margin oil. It is for this reason that major oil and gas companies like Petrobras (NYSE: PBR) and BP (NYSE: BP) are aggressively expanding in Angola to improve their overall profitability.
As a matter of fact, BP has sold around $50 billion worth of its assets over the last two years in order to focus on its core competencies and move towards high-margin projects. The oil behemoth has 15 upcoming oil projects, out of which 11 are high-margin projects. And according to its latest press release, its Clair Ridge field is expected to commence operations this year, which will effectively double its cash flows from Angola.
Meanwhile, Petrobras recently announced that it is looking for partners, to share the project development costs in Angola. As of now, Petrobras is operating with a massive net debt of $74.8 billion, and recently raised $11 billion by issuing bonds. Needless to say that its debt is towering, making it one of the most debt-ridden oil companies.
Since both BP and Petrobras are well diversified companies, a handful of their Angolan projects don’t seem enough to set their financials soaring. However, Cobalt International is less than one-tenth the size of BP (by market cap) and is leveraged heavily towards its high-margin projects in Angola. Hence it makes sense to buy Cobalt over its larger peers.
Apart from that, Cobalt International sports a clean and healthy balance sheet. The company operates with a modest debt/equity ratio of 39% while its current ratio stands at a hefty 12.5x. It also retains 100% of its earnings, which is great for a rapidly growing company. With these numbers, I don’t think that Cobalt will run into any debt-related concerns anytime soon.
But it's worth noting that Cobalt International posted a loss of $376 million last year, and its Angolan oil production won't commence before 2016. It remains a speculative bet and a lot depends on its upcoming drilling results. With that said, Angolan reserves are hydrocarbon-rich and it is highly unlikely that its results would be lackluster. It is for this reason that analysts at Deutsche Bank are bullish on Cobalt International with a price target of $41 per share (around 65% premium).
Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!