How to Research an Oil Stock: Part 1

For investors who don't make a living in the oil patch, the energy sector can be tough to approach. I try to peel back the onion a bit with my coverage of everything from Anadarko Petroleum's (NYSE: APC  ) cycle times to Chesapeake Energy's (NYSE: CHK  ) basis differentials, but I realize that some of this commentary can seem totally obscure to those less familiar with the value drivers in this business.

This week, I'll try to walk you through my own thought process when looking at an oil and gas exploration and production (E&P) company for the first time. To clear away at least some of my biases, and put us on more equal footing, I've chosen a company -- Gulfport Energy (Nasdaq: GPOR  ) -- that I knew nothing about before this exercise. By giving you a peek at my approach, I hope you'll pick up some ideas of what to look for when investigating an E&P on your own.

Start with the share structure
Right now, all we know is the name and ticker symbol of our E&P. To do our digging, we'll want to pull up a few documents. From the company website, I've grabbed the 2008 annual report and the most recent investor presentation, dated Aug. 6, 2009. From the Securities and Exchange Commission's EDGAR database, I've plucked the most recent quarterly filing (10-Q) and the proxy statement accompanying the notice for the 2009 stockholders' meeting (DEF 14A). That's about all we need for now.

Here are some of the very first data points that I hunt for:

Share Structure and Capitalization

Numbers

Shares outstanding

42,670,750

Options outstanding

518,630

Fully diluted share count

43,189,380

Recent share price

$8.00

Market capitalization

$341 million

Cash and equivalents

$6.9 million

Debt

$64.8 million

Data from company filings.

There's nothing specific to oil companies about this first step. These considerations are universal. Some early observations:

  • The share count has risen by about a third since the end of 2004. That's not great, but not terrible, either. See Petrohawk Energy (NYSE: HK  ) for a real spike in share count.
  • The options overhang is minimal, and none have been granted recently.
  • Gulfport has almost 10 times as much debt as cash.

Now, there's nothing necessarily wrong with this debt load, but that's immediately where my attention is drawn.

Liquidity has become a luxury
Reviewing the components of Gulfport's debt, we see that the majority is from a revolving credit facility with Bank of America. This is a very common funding source for a small to midsized E&P, and one that I've focused on in my coverage of the crude credit crunch. The 10-Q tells us the revolving loan had $59 million drawn against a borrowing base limit of $90 million, as of the end of the second quarter. The facility expires in March 2010 (i.e., less than a year from now), which is why these borrowings are classified as current liabilities. Gulfport says that "the lender has indicated an intent and willingness to renew and extend the maturity date," which is the normal course of things. Then again, these are hardly normal times.

Note that after the market shut down for the long weekend on Friday, Gulfport reported to the SEC (without issuing a press release) that its borrowing base was unceremoniously cut in half following a redetermination by its lender. Was the company hoping no one would notice?

That exceeds the 41% cut experienced by McMoRan Exploration (NYSE: MMR  ) earlier this year. Unlike Stone Energy's (NYSE: SGY  ) slightly more accommodating lending group, Bank of America took Gulfport's borrowing base limit below the amount outstanding, meaning that the company is suddenly overdrawn by $14 million. This excess amount (somewhat bigger than operating cash flow in the second quarter) has been converted into a term loan with the same maturity date as the revolver.

This liquidity pinch comes close on the heels of Gulfport's recently relaunched drilling program, which certainly makes things "interesting." An equity offering that moderately dilutes the share count would follow the precedent set by Brigham Exploration (Nasdaq: BEXP  ) and countless others, and I would consider that the most likely course of action.

Still, the company may have other options. Gulfport sold some Bakken assets in the second quarter for $13 million, and could sell off other properties. To assess the company's ability to claw out of this hole without soaking shareholders, we'll have to give the E&P's assets, production, and cash-flow profile a good, hard look. That's what we'll do in Part 2.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. Chesapeake Energy is an Inside Value recommendation. The Motley Fool owns shares of Chesapeake, and has a diligent disclosure policy.


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