Is Kodiak Oil & Gas the Perfect Penny Stock?

Low-priced stocks are often low-priced for a reason: They have significant problems to overcome. Yet for those that have fixed their problems, they may be ready to take off to the next level.

At Motley Fool CAPS, a "penny stock" is any stock trading under $10, and you'll find some of the best CAPS All-Stars regularly seeking out winning single-digit investments. We identify them with a penny icon, and by pairing up their opinions with some top companies trading for pennies on the dollar, relatively speaking, we may end up with more than just chump change.

Of course, just because a stock is low priced, isn't necessarily enough to suggest it will have an easier time recording big gains. Low-priced stocks are often low-priced for a reason. But this week, we look at independent energy play Kodiak Oil & Gas (NYSE: KOG  ) , which has seen its shares surge 48% over the past year, now trading just north of $9 a share, and garnering top honors at CAPS.

Kodiak Oil & Gas snapshot

Market Cap $2.4 billion
Revenues, TTM $187 million
Return on Investment 1.3%
Dividend & Yield NA/NA
Recent Price $9.07
CAPS Rating ****

Growth is growth
We'll know in a couple of weeks whether Kodiak's first quarter was just a breather for the oil and gas driller or if it represented the start of a new trend. But you can put me in the column of those who think it's the former rather than the latter because while the results may have come up short of analyst expectations, they represented rip-snortin' growth and positioned the company to capitalize on the industry's strengths going forward.

Through a program of acquisitions, Kodiak is expanding its acreage and production. In the first quarter of this year, oil sales volume surged 458% in large part because of its acquisitions, but it also increased production at its legacy properties. Of the 721 MBbls increase in sales volume, 43% was related to acquisitions, which means it's getting the lion's share from its existing properties. Similarly, its natural gas production is also benefiting from acquisitions, but legacy properties are still pulling their weight.

Some are more equal than others
Recently, the governor of North Dakota admitted he's been "so wrong in the past" guessing how big the state's oil industry could get that he's not even going to hazard a guess anymore. That's OK because analysts say the Bakken and Three Forks regions to continue being the key to domestic production and regulators chime in calling for North Dakota to double to more than a million barrels a day by 2015. The state is second only to Texas in oil production as the Bakken formation has produced a major booming economy there.

Continental Resources was one of the first exploration companies to realize the region's potential, but now there's seemingly no end to the list of drillers now digging deep into the rock to get at its resources. Kodiak itself has six wells in operation and recently took delivery of a seventh.

The market seems to be discounting much of the potential, particularly since just 41% of its 168,400 acres are developed. Weak oil and gas prices may have contributed to the decline -- Kodiak's stock peeled back more than a third of the gains it had achieved at the end of June -- but it's bounced back almost 30% from those lows. The same can't be said for other players in the region as Continental, Whiting Petroleum (NYSE: WLL  ) , and Hess (NYSE: HES  ) haven't recovered nearly as much ground, and Samson Oil & Gas (NYSE: SSN  ) continues dropping lower.

Out of time
While I like to value companies based on how their enterprise value stacks up against their ability to generate free cash flow, Kodiak has been investing in itself fairly heavily so that it is currently FCF-negative -- so I can't do that. Yet looking at the multiple the market has assigned it based on estimated earnings, it compares favorably with its weaker rivals and is put on the same level as those that are faring better when accounting for their growth potential.

While the natural gas industry remains depressed from an inventory glut as operators like Kodiak and SandRidge Energy (NYSE: SD  ) continue to service their wells, it eventually means that when prices recover -- as they will -- they'll be selling cheaper gas at higher prices that will translate into even greater profits.

Because of these factors, I'd already rated Kodiak to outperform the market on CAPS last month, but you can tell me in the comments box below or on the Kodiak Oil & Gas CAPS page if you agree, this penny stock energy play makes perfect "cents" for your portfolio.

Make some change
Energy prices remain roiled by events in the Middle East, but some analysts think a new spike is just around the corner. The Motley Fool has identified the one company it thinks will profit from a new age of high oil and gas prices. Get your copy of this free report "The Only Energy Stock You'll Ever Need" by clicking the link and downloading it today. Did I mention it's free?

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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