A Bear of a Time With Kodiak Oil & Gas

Wall Street pros have nothing on retail investors who stake small sums of money monthly on undervalued small-cap stocks. Because they're mostly ignored by the big guns, these types of stocks offer the best, outsized opportunities for growth.

I screened for stocks under $3 billion in market cap, offering earnings surprises of 15% or more in the previous quarter, with a forecast for long-term-earnings growth to be at least 15%. One stock that floated to the top was independent energy play Kodiak Oil & Gas (NYSE: KOG  ) , which saw earnings jump 18% ahead of analyst expectations; Wall Street expects its earnings to grow 50% annually for the next five years. With a $2.4 billion market cap it makes it into our range for potential investment candidates.

Of course, don't jump on a stock just for those reasons. It should just be a starting point for more research as we need to look more closely to see whether analysts' faith in them is well-founded.

Dialing up opportunity
Focused on the Bakken Shale region in the Williston Basin of North Dakota, Kodiak is a bet that the area continues to be a top-tier performer – so far it's living up to those expectations. Average third-quarter production quadrupled from last year's third quarter, and was up 26% sequentially, standing at 15,855 barrels of oil equivalent per day. Crude oil revenue accounted for almost all of its oil and gas sales in the period.

The results being achieved by Bakken players like Kodiak has attracted the attention of larger oil companies like ExxonMobil (NYSE: XOM  ) , which spent $2 billion to acquire from Denbury Resources (NYSE: DNR  ) the drilling rights to 196,000 acres in North Dakota and Montana, thereby extending its presence in the Bakken by 50%. 

According to Bloomberg, crude production in the region has tripled over the past four years to reach a record 610,000 barrels a day in the third quarter. Drillers like Kodiak were getting a premium for their crude over West Texas Intermediate because they were able to bypass infrastructure bottlenecks by shipping their output via rail, though Hurricane Sandy affected prices as railroads shut routes and refiners closed facilities. According to the North Dakota Pipeline Authority, 46% of Bakken crude was shipped by railroad in August.

Exxon's acquisition puts it in fifth place behind the Bakken's biggest player, Continental Resources (NYSE: CLR  ) , followed by Hess (NYSE: HES  ) , Whiting Pretroleum (NYSE: WLL  ) , and ConocoPhillips (NYSE: COP  ) . It also makes Kodiak, a near pure play on the region with 150,000 net acres in North Dakota, an attractive takeover target.

Analysts are expecting the Bakken and Three Forks regions to continue being the key to domestic production, with regulators in North Dakota calling for a doubling to more than a million barrels a day by 2015. Continental's CEO thinks that is on the low side, but North Dakota is second only to Texas in oil production.

Hanging up on future growth?
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. At just over 12 times earnings estimates, however, Kodiak trades in line with its larger brethren, but when factoring in analyst estimates of earnings growth only Continental offers a more attractive profile.

Earlier this summer I rated Kodiak to outperform the broad market averages on Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion in stock ratings of one to five stars. Since then the stock has appreciated nearly 12% compared to a rise of less than 6% in the S&P 500, giving me a winning advantage at the moment.

Because of the fundamentals at play in the region I expect that score to widen in my favor, particularly if some other oil giant comes knocking, as I suspect one might. Kodiak Oil & Gas is a dynamic growth story, but with great opportunity comes great risks and to help with your due diligence to see if Kodiak is a currently a buy or sell, check out our new premium report, which comes with a year of timely updates and analysis. 



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