There has been a gradual shift in what exploration and production companies consider to be the next hot commodity. That shift becomes quite apparent when oil companies start physically turning into natural gas companies! Not one to miss out on the party, Houston-based Plains Exploration & Production
So the question is: Is Plains E&P possibly going to make you a lot of money looking into these future investments?
Plains E&P has already seen a growth in its operational earnings (EBITDA) in 2010, thanks to higher production levels and sales of natural gas. Its Haynesville shale reserves produced 43 billion cubic feet in 2010 -- a hefty 183% growth from 2009. The company's joint development program with Chesapeake Energy
Another great shale gas resource -- the Eagle Ford shale play -- is also figuring prominently in the company's plans. The 2011 capital budget is set at $1.2 billion, primarily targeted toward further development of its resource plays in these regions.
Yet underneath it all, I'm finding that things are a lot less straightforward than they initially appear. Current debt levels could be of some concern for this company, for example. Debt-to-equity stands at an unenviable 100%. The company's interest coverage ratio, while still a healthy 7.4 times, is at its lowest level in the last five years. As this debt matures and more is due, the burden of a highly levered business won't be sitting lightly on management's shoulders.
Free cash flow stands at a -$1 billion. With a high debt level and a poor cash balance, funding for capital expenditures might be a problem. Taking more loans for expansion might not be the solution either for obvious reasons.
A current ratio of 0.6 time doesn't look too good either for the long-term investor. This business is running lean.
How is the stock valued?
This is how Plains E&P stacks up when compared to its peers:
Return on Assets
Pioneer Natural Resources
Source: Capital IQ, a Standard & Poor's company. TTM = trailing 12 months.
Plains E&P doesn't look too cheap, especially given its balance sheet weakness. I believe the overall market has valued this stock rationally. A low price-to-book seems justified as the company's ROA, as evident, is the lousiest of the bunch. What I'm essentially seeing here is a company with great potential, but one that is also not appropriately capitalized to succeed. Investors beware.
Foolish bottom line
On paper, the company's plans for the future look great. However, a deeper look into its finances shows a different picture. Plains E&P needs to work harder to generate some much-needed cash. This might not be too easy. Foolish investors should wait a little more to see if this company can turn up profits consistently. The transition to natural gas exploration from primarily oil exploration does not come too easy -- and not everyone looks capable of exploiting the imminent boom in natural gas demand.
Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. 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.