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The Multibagger Oil Stock I'm Buying

Warren Buffett gave us the secret to making big money in the stock market: Be a greedy buyer when fearful investors are selling.

Nervous investors have been selling shares of oil company Denbury Resources (NYSE: DNR  ) . The stock is down more than 41% since its high on April 5, 2011, compared to the market's 9% decline (through Sept. 16, 2011). So it's time to get greedy.

As you'll read below, Denbury is a unique company built to grow profitably for decades. I'm purchasing shares for my "Trends and Trades" portfolio. Like you, I can't resist a good chance to earn multibagger returns. Here's how I see it happening.

The trends
Two trends for oil in the U.S. remain strong: Production is rising while reserves are falling. See the charts below.

Since 2009, the price of oil has nearly doubled while the price of natural gas has fallen more than 30%. The combination of falling reserves, growing consumption, and rising prices creates big profit opportunities for domestic energy companies. That's why SandRidge Energy (NYSE: SD  ) , EOG Resources (NYSE: EOG  ) , and Chesapeake Energy (NYSE: CHK  ) , to name a few, have shifted their drilling resources to oil and from natural gas.

A unique oil company
Traditional energy companies invest billions of dollars scouring the land to find and drill for oil. Texas-headquartered Denbury, led by CEO Phil Rykhoek, plays the game a little differently -- and better.

The company buys older wells full of oil that's been left behind. Why would Denbury buy wells others don't want? Because it knows how to extract those precious last drops that the previous owner couldn't get to.

The ace up Denbury's sleeve is enhanced oil recovery. It is the second-largest EOR player by production volume, behind Occidental Petroleum (NYSE: OXY  ) . Denbury injects carbon dioxide into an existing well. The gas fills the well and mixes with the oil, making it more slippery. The pressure forces the remaining oil out of the crevices to the surface. After a little cleanup, the crude is ready for market, and the CO2 that isn't recycled remains sequestered in the ground.

Denbury owns Jackson Dome, the only naturally occurring CO2 deposit east of the Mississippi River, giving it a huge advantage. Jackson Dome can supply more than 20 years of CO2 to Denbury's Gulf Coast oil fields in Louisiana and, most recently, east Texas. Using EOR, Denbury spends around $40 to produce a barrel of oil. That makes each barrel of Denbury's oil profitable over a wide range of oil prices -- and very valuable today.

Built to grow
The Gulf Coast region has 3.4 billion to 7.2 billion recoverable barrels, according to the Department of Energy. By comparison, Denbury owns 492 million barrels of proved and probable reserves in the region, or about 7%-14% of the potential in the region. And Denbury's new Green Pipeline flows through the middle of all the older fields in east Texas, creating future opportunities.

Not satisfied to stay in the South, Denbury ventured west via the strategic purchases of Encore Acquisition, an exploration and production company, and Riley Ridge Federal Unit, a large source of CO2 and other gases. The company now has a strong foothold to build out another EOR platform in the Rocky Mountains. Its CEO believes Denbury can average 13%-15% annual EOR production growth for at least the next 10 years and still have plenty of properties to purchase more growth in the future. It also owns 266,000 net acres in the Bakken Shale, one of the hottest shale oil properties today. Denbury will be gushing profits!

Trading for a great price
EOR gives Denbury a huge advantage. Profit per barrel is high, no one can replicate the Jackson Dome CO2 deposit, and there are plenty of oil fields to purchase near its pipelines. The company has taken its know-how on the road, replicating its Gulf Coast operations in the Rockies. Plus, it owns a small part of the Bakken Shale, which has turned out to be a great discovery.

I don't know why the market dislikes Denbury right now, but I am not waiting to find out. The price is too good to pass up. Relative to the competition, Denbury looks like a fantastic opportunity. Look at the price-to-book comparisons below.



Denbury Resources 1.2
SandRidge Energy 1.9
Encana (NYSE: ECA  ) 1.0
Chesapeake Energy 1.5
Rosetta Resources (Nasdaq: ROSE  ) 4.0

Source: Capital IQ, as of Sept. 13, 2011.

If the multiple expanded to the average of the competitors in the table, it would generate a 75% return.

That's nice, but it's not a multibagger.

The trade
I estimated the market value, rather than the book value, of its assets using various oil prices. I think the price of oil will trend toward more than $100 per barrel over the next five years. There will be ups and downs along the way, but prices are likely to stay higher. At $100 oil, I think Denbury could trade for $40 in three to five years. That's more than a triple from today's prices!

The stock has risk. If lower oil prices persist for a number of years, the value of its production and reserves will decrease. Also, it's never easy to build a pipeline. Any regulatory setbacks would throw off its production schedule. But according to the trade plan below, Denbury is worth the risk.

Source: Author's calculations.

I am buying an average-sized position (3% for my "Trends and Trades" portfolio) at today's price. I'd be willing to take the allocation to 10% at prices below $10.

Foolish bottom line
Many investors don't like Denbury Resources and have been selling their shares. According to Buffett's philosophy, greedy buyers of this energy company should make out like bandits. I've given my thoughts, but I'd love to hear yours. Click here to chime in on the "Trends and Trades" discussion board. And you'll never miss any of the action if you sign up for my Twitter feed at @trendsandtrades.

David Meier is an associate advisor for Million Dollar Portfolio. The Motley Fool owns shares of Denbury Resources. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. 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.

Read/Post Comments (2) | Recommend This Article (36)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 29, 2011, at 11:50 AM, CMFTomBooker wrote:

    "The stock has risk. If lower oil prices persist for a number of years, the value of its production and reserves will decrease. "

    lol. ;)

    The only way oil could persist at a low price for longer than it takes to have a cup of coffee and buy more shares, is if the laws of physics drastically change. Or JPM oil commodity prop group is arrested and permanently banned.

    OT: IMHO, this is not an adventure, it's a freakin' start-up. Tell the Big G to cough-up a couple of boards for it. I'll "host" them for you without a TMF affiliation, which will permit Gonzo-enhanced investing without soiling the TMF brand, or inflicting the usual legal costs involved with my writing.

    We can be through Discovery, Validation, and have a product/market fit before anybody realizes what we're up to.

    All you have to do is show up to announce the company and price ladder. In your spare time you can answer questions if you want and/or develop courseware for the formal/official start-up.

    Billable hours look pathetic thru Dec. and I'm just going to get into trouble, if I don't have something to do.

  • Report this Comment On October 19, 2011, at 11:53 PM, CMFSwift wrote:

    Check out Jeremy Grantham's two part series on natural resource limits ( Mag a few weeks ago). The great prognosticator of asset bubbles says the normal bubble formula will not work for finite natural resouces (duh!). We are seeing a paridigm shift in this area, the usual return to mean that defines all asset bubbles, will not apply to this class as human population continues to explode and more people move into western style living. Under $10 would have been nice, but $10.99's not looking so bad either. :-)

    BookerT, they haven't given you an official role yet, geeeez, didn't anybody at TMF read Moneyball ;)

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