The Best Stocks for 2010: ATP Oil & Gas

What a difference a year makes!

Last December, the collapse of crude oil had me seriously spooked. I almost abandoned the energy sector entirely with my Best Stock for 2009 pick. Fortunately, I stuck with what I knew and went with what I dubbed "the ultimate hunker-down oil service stock" -- Core Laboratories. This turned out to be one of the best picks of the bunch.

Given the market's stretched valuation, it will be tough to pull another near-double out of my jester's cap. Of course, that's not going to stop me from trying to repeat my prognostication feat.

Two familiar faces
As mentioned in my recent musing on the market's best energy stock, two of my favorite small cap shops in the space are Contango Oil & Gas (AMEX: MCF  ) and ATP Oil & Gas (Nasdaq: ATPG  ) . Each follows a unique path to upstream profits, and I expect both companies to reward patient shareholders. Contango, which joins XTO Energy (NYSE: XTO  ) and Southwestern Energy (NYSE: SWN  ) on the list of the past decade's 10 best stocks, already has.

I've decided to go with the stock that gets less respect, and also has a clearer catalyst in place to unlock value in 2010. That would be ATP.

Arrested development
If wildcatting gives you the willies, ATP Oil & Gas may be up your alley. The company has a focused program of buying proven, yet undeveloped, offshore fields and bringing them into production. That's exactly what ATP has done at its Gomez Hub and is in the process of achieving at its new Telemark Hub, both in the deepwater Gulf of Mexico.

We've seen the deepwater ding other small players, and even Devon Energy (NYSE: DVN  ) has recognized that it had gotten in too deep. Did ATP cruise through the commodity crack-up without a hitch? Hardly.

The funding requirements for ATP's Telemark Hub make the Avatar budget look like no biggie. The floating drilling and production platform alone cost over $600 million. ATP has also had Diamond Offshore (NYSE: DO  ) and other contractors drilling development wells for a pretty penny. These various costs crescendoed right around the time that credit markets were most dysfunctional. ATP's balance sheet became a real burden.

By bringing in General Electric (NYSE: GE  ) as an investor in one production platform, wringing concessions out of Diamond and other service companies, and raising some dilutive capital, ATP did make it through in one piece. That's a true testament to the quality of both the assets and the people at ATP.

I'm speaking in the past tense, as if nothing can go wrong from here. Several things can go awry from here, but ATP's shares are discounting more risk than is evident to me at this late stage of Telemark's development. We'll return to possible risks once we get a handle on this project's potential.

Telemark looks tantalizing
The Telemark assets, comprising the Mirage, Morgus, and Telemark fields, were purchased from Statoil back in 2006. They are a game-changer for ATP.

In the third quarter, company-wide production came in at 1.4 million barrels of oil equivalent (boe), or a bit north of 15,000 boe per day. Back in March, ATP's President stated that the first Telemark well should produce over 10,000 boe per day. That's the largest of several well completions that we should see at the Telemark Hub by mid-2010. These wells alone should more than double ATP's third-quarter production rate.

As far as reserves upside, we got a taste in September with the drilling results at the Mirage #3 well. ATP encountered twice its pre-drill estimate of hydrocarbon "pay." With a new reserve report right around the corner, this is another potential catalyst for the stock. Of course, investors are far more fixated on ATP's cash flow relative to its significant financial obligations, so reserves definitely take a back seat to production growth.

This pick's not without risk
ATP has kept its head above water, but the firm still has over $1 billion of debt. Roughly equivalent to the firm's entire market cap, this is no trivial sum.

The firm's key challenge in 2010 is to generate enough cash to both cover its capital budget and take a meaningful chunk out of this debt balance. I don't think operations alone will cut it, because a fair bit of operating cash flow will be diverted to satisfy service companies' net profit interests at Telemark. ATP's cash could get tight without a successful monetization of the ATP Titan, the Telemark Hub's floating platform.

GE invested in half of the Gomez Hub's ATP Innovator at cost, and if they or another investor were to do the same with the Titan, that would bring in around $300 million pre-tax. I think ATP can pull this off, but it's not a sure thing.

Another risk is that the Telemark wells experience production problems, and require expensive sidetracks or recompletions. This could also cause ATP to face a crunch in 2010.

This is not a "set it and forget it" stock. ATP's unique situation demands attentive ownership. Fortunately, the stock's message board is one of the best in Fooldom, and a great place to continue your research.

Which is the best stock for 2010? See all 13 candidates here.

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Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. The Motley Fool owns shares of XTO, and has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (42)

Comments from our Foolish Readers

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  • Report this Comment On December 30, 2009, at 4:36 PM, JustMee01 wrote:

    Toby,

    A good summary of ATP's highlights. Word limits probably cramp things, since there's so much going on!

    Right after Telemark comes on line (lets say 2Q 2010, to be pessimistic?), the Octabuoy will be nearing to completion and only a year or so from sailing out to Cheviot. Then the debt concerns could be revisited. How that's received by the market will be interesting. I think that many investors would like to see them monetize Titan quickly to eliminate that risk, since another $600M or so will appear in 2011 for the Octabuoy. Then the strain might come off the shares and we'll pop? We'll see...

    Cheviot is another large field and should keep them in the spotlight, as this little independent continues to defy the odds and play in the pond with the big fish. It's one of those stocks that's just plain fun to follow...

    You mention that you're bullish on Contango. I'm curious about Contango, scouting it and know less about them. I like the drop in valuation, and the fact that they're unhedged on NG, but still profitable. Their costs are impressively low. Have you written anything about them? I'm most curious about the relationship between Contango and Juneau, and where they go from here. They don't seem to historically be interested in the "P" of "E&P". Yet, the Mary Rose and Dutch wells have boosted production a ton. Are they likely to keep these properties, or monetize the find to fund more exploration? Any ideas on where they go from here?

    Thanks,

    Peter

  • Report this Comment On December 30, 2009, at 5:49 PM, j7777k wrote:

    Toby,

    I currently own 3 of the 13 stocks nominated for best stock in 2010 of which ATP oil and Gas is one, but will limit my comments to only ATP. To me it is clearly the one with the most potential for price appreciation in 2010.

    As you said the Telemark field coming on line the March time frame will be a huge catalyst for the stock. Once all 4 wells are producing by 4th Qtr of 2010, production will have increased to triple what ATP produced in 3Q09. Since Mirage, Morgan, and Telemark (the Telemark field combined) is 76% Oil, ATP's overall production profile by the end of 2010 will be 68% oil 32% NG. This fact makes me smile every time I look at Nymex strip pricing for Oil and NG

    Monetizing Titan and the Telemark pipelines should bring in $460M. This along with the above production increases should bring he debt down considerably in 2010 and 2011 and fund the Octobouy for the Cheviot field in time for 2012 production start-up.

  • Report this Comment On December 31, 2009, at 1:48 PM, JustMee01 wrote:

    To mcfexpert:

    In reference to the statement that MCF seems focussed on the E in E &P, you asked:

    "How can you say that. They have 100 % PROVED PRODUCING RESERVES."

    I can say that because THEY say that and I'm interested in what others know. They state multiple times in presentations and SEC docs that they see the "E" in E&P as the area where value is created, and that this is where they want to focus. It's all over their 10-Ks and 10-Qs, and they characterize themselves as "wildcatters" in presentations and PR. 2 + 2 = 4. This is their own stated business model.

    My question, which I don't know the answer to, is does this move toward keeping some production seem permanent, or will they go back to monetizing properties. It changes how you might value the company. when NG prices rebound If they keep this production and operate themselves, they're nice and low risk and easier to value based on production.

    If not, there's a variable that needs to be accounted for in some way. I'm simply asking where people think they go from here. Will they sustain the production themselves, or will they monetize the asset and continue their exisitng business model? The market seems to prefer the cash machine that you reference. Do they prefer to keep that cash machine intact, or strike out for new pay?

  • Report this Comment On January 01, 2010, at 10:57 AM, texasflyfish wrote:

    Reward and risk are opposite sides of the same hand. Of the 13 stocks listed, I think you're right. There is some risk on ATP as described above, but there is a pretty good chance (70-75%) that it will rocket.

  • Report this Comment On January 01, 2010, at 8:34 PM, tkell31 wrote:

    Just based on the pitch my question would be this is the best you could come up with? Not trying to be clever or anything, but it seems like of all the stocks out there you would be able to pick one with just as much potential, but less risk.

  • Report this Comment On January 03, 2010, at 1:51 PM, XMFSmashy wrote:

    tkell31,

    ATP has a clear path to doubling or tripling its production in short order. It's the only fair-sized E&P I know of with such a profile.

    I'm glad you've considered the risks. I tried to make it clear that there are plenty of potential pitfalls. Many investors find ATP too risky, which is reflected in the share price. We'll see if those risks have been appropriately discounted as the situation unfolds.

    TS

  • Report this Comment On January 28, 2010, at 7:39 PM, tkell31 wrote:

    With negative trailing EPS projected for most of 2010 (I believe when second quarter 2010 gets reported in September or so it will just be swinging to a positive trailing eps) I think there will be a better entry point. I'm pretty sure I will miss it, but going to keep tracking it since the projection for 2011 look great. Best of luck.

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