Is PetroQuest Energy the Best Small-Cap Energy Stock?

Forbes ranked independent oil and gas company PetroQuest Energy (NYSE: PQ  ) sixth among the 200 best small companies of 2008. Unfortunately, that was the only year the company made it to the coveted list. While these rankings should matter very little to the long-term investor, it does makes sense to find out if the company is worthy of consideration.

What really matters to Fools is whether the company has fundamentally strong operations that are able to generate profits in the long run. Closely related to that would be whether the returns are worth the price we pay for the stock. That's what I'm looking at.

Fundamentals
With regards to operations, total production for the company fell 9% in 2010 as compared with 2009. Natural gas production fell by 13% during the same period. Reduced capital spending in 2009 and declining production in Gulf Coast assets contributed to this fall. While this is not exactly a great thing, management was desperate to pay off debts.

Debt-to-equity currently stands at 71.5% -- a significant drop from 152.7% two years ago. The 2008 economic downturn forced management to focus on strengthening the balance sheet and increasing liquidity.

Solid strategy
Things are looking brighter as PetroQuest is focusing on growing its longer-life assets. Its diversification into the natural gas shale plays of Woodford and Eagle Ford should serve it well for a long time. At the end of last year, 87% of proved reserves and 54% of production were derived from these assets.

Total reserves have grown to 193 billion cubic feet equivalent (Bcfe) in 2010 -- an 8% jump from the previous year -- with the Woodford shale representing more than 15% of total proved reserves. Natural gas constitutes 79% of total reserves, which positions PetroQuest to exploit the impending boom in the commodity's demand.

How is the stock valued?
This is how PetroQuest stacks up compared with its peers:

Company

EBITDA Margin

(TTM)

TEV/EBITDA

(TTM)

P/B

TEV/DFCF

PetroQuest 65.1% 5.9 2.8 1.9

Magnum Hunter Resources

(NYSE: MHR  )

(9.5%) NM 6.2 6.4

Crimson Exploration

(Nasdaq: CXPO  )

43.1% 7.5 1.0 0.7

GMX Resources

(NYSE: GMXR  )

51.6% 13.5 1.5 1.0

ATP Oil & Gas

(Nasdaq: ATPG  )

49.0% 12.6 8.2 0.4

Source: Capital IQ, a Standard & Poor's company. TTM = trailing 12 months. EBITDA = earnings before interest, taxes, depreciation, and amortization; TEV = total enterprise value; P/B = price-to-book; DFCF = discounted future cash flow. NM = not meaningful.

PetroQuest's numbers look compelling compared to other small-cap energy stocks. Its EBITDA margin shows that it has done well converting revenues into earnings. Comparatively, it looks the cheapest in terms of its enterprise value. I feel this stock is undervalued given the huge potential it has and given that the market is yet to fully factor in future cash flows. Discounted future cash flows look attractive when compared against the total enterprise value.

Foolish bottom line
The stock looks pretty attractive to me. While short-term gains don't seem overly probable, management is slowly and steadily building on its long-term potential. The stock looks cheap today, but may not remain so forever.

Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. 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.


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