For a few years now, oil has traded at a hefty premium to natural gas prices in the United States. Because of this divergence, many oil and gas companies have refocused their operations to focus on higher-return oil projects. This is a multiyear trend in the making, so I'm always on the lookout for companies that might benefit from the shift. One small cap that has been focusing on liquids is Abraxas Petroleum (Nasdaq: AXAS ) .
Company snapshot
| Market Cap |
$315 million |
| Net Debt |
$104 million |
| TTM OCF |
$33 million |
| TTM Capex |
$69 million |
| Price-to-OCF Ratio |
9.6 |
| Proved Reserves at Year End 2010 |
26.6 million BOE |
| Recent Price |
$3.36 |
Source: S&P Capital IQ.
One thing that jumps out at me is that the company's trading at almost 10 times operating cash flow, much higher than established players such as Devon Energy (NYSE: DVN ) , Denbury Resources (NYSE: DNR ) , and Whiting Petroleum (NYSE: WLL ) , which can all be purchased for multiples of just 5 and 6. Moreover, $104 million is a fair amount of debt compared with its market cap of $315 million.
The debt and valuation numbers don't exactly pop off the screen, but smaller companies shouldn't be judged solely on recent performance, since they're usually in the process of ramping up. Every well that comes online usually provides a noticeable bump in production and has a greater impact on overall production growth, so we need to examine its portfolio of assets and see where the company might go in the future.
Taking a closer look
Abraxas has acreage in the Alberta Bakken, Bakken / Three Forks, Niobrara, Eagle Ford Shale, Permian, and Barnett shale plays. Among the more important assets are 50,000-plus net acres in the Bakken, Eagle Ford, and Niobrara, emerging sources of unconventional oil. In the Bakken and Niobrara alone, the company will spend roughly half of its projected $60 million capital budget for 2011.
Ever since natural gas prices decided not to rebound with other commodities, companies have been skewing their capital spending toward liquids plays. Abraxas will be increasing its capital spending in 2012 to $70 million, a 17% increase over the projected 2011 budget. All of that spending will be targeting oil and natural gas liquids.
As of the end of 2010, Abraxas hedged 66% to 82% of both its oil and gas production going out to 2013. The oil hedges are out of the money, with prices averaging $75.69. The gas hedges, however, are very attractive, with an average price of $6.69. As the company spends heavily on oil and liquids, further oil hedging should slowly bump the average up.
Looking forward
One thing that's attractive about Abraxas is that most of its acreage is held by production. That means the company's not forced to drill just to hold on to acreage, but it can allocate capital to its highest-return projects. That's a big positive, since the company prides itself in having a diverse portfolio of emerging unconventional oil plays in the Bakken, Eagle Ford, and Niobrara shales.
The company has yet to announce exactly where the capital-spending budget will be allocated, but one can be certain that a large portion of it will go to the Bakken. Of the 2011 budget, 43% was allocated to the area in 2011, and the company even purchased a drilling rig to ensure its ability to maintain drilling in the area given the high demand for oilfield services.
It's interesting to see a smaller player moving to become vertically integrated, but the economics appear to make sense. The company expects its three-year well costs to come down $13 million, compared with the cost of contracting out for a rig instead. As long as the company can keep the rig utilized at a high rate, it's hard to argue with the move.
Foolish bottom line
Abraxas is not exactly the cheapest at almost 10 times operating cash flow, but it's making the right moves to accelerate development in key liquids-rich areas. If the company can continue its current course, it should start to reap the benefits of its new oily focus.
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