The growth we are seeing in oil production here in the states is such an exciting development. A few years ago we were talking about peak oil and the possibility that we'd one day run out of the stuff. Now, with emerging oil plays like the Bakken we're dreaming of energy independence.
One of the exciting companies operating in the Bakken is Kodiak Oil & Gas (UNKNOWN:KOG.DL). What's exciting about Kodiak is that it grew its production by 270% last year while its reserves were up 138% year over year. Production and reserve growth is great but we need to bear in mind that the company still needs to make money. Let's take a quick look at the risks to Kodiak's financials by taking a more critical, dare I say, bear-ish look.
Balance sheet and liquidity
Kodiak, like most energy companies, carries a decent amount of debt. At the end of 2012 the company had $1.15 billion in senior notes and $450 million drawn on its credit facility. The earliest its senior notes are due is 2019 so there are no near-term liquidity concerns and its most recent tranche of debt came with a reasonable interest rate of 5.5%. Kodiak has about $450 million in overall liquidity to help it execute on its 2013 growth plans.
Liquidity and balance sheet flexibility are absolutely imperative for an exploration and production company. We've seen larger peers like Chesapeake Energy (NYSE:CHK) and SandRidge Energy (UNKNOWN:SD.DL) forced to sell assets because of debt-laden balance sheets. Chesapeake is in the process of selling $4 billion-$7 billion in assets including a recent billion dollar sale of a 50% interest in its promising Mississippian Lime acreage. Meanwhile, SandRidge sold its terrific Permian Basin assets for $2.6 billion so that it could fund its Mississippian drilling program. Kodiak need not follow in those footsteps; instead it should live within its means. So far it hasn't done that but it appears that the company could be cash flow positive by 2014.
Earnings and cash flow
After reporting virtually no earnings the past three years, Kodiak turned in a profit of $0.50 a share for 2012. Kodiak also reported net income of $131 million and cash from operations of $272 million. For perspective, the company earned just $4 million last year with cash from operations just shy of $54 million. The company is estimated to grow earnings to $0.68 a share this year and hit $0.88 a share in 2014. The good news here is that its earnings and cash flow are heading in the right direction.
Kodiak plans to spend about $740 million in 2013 to drill 75 net wells. This will be partially funded through its cash from operations while the company will be tapping its credit facility to fund the balance. That means 2013 will be another year of burning cash for the company and another year that it bumps up against its limits. The good news is that as the company adds reserves and production, it can raise capital to extend those limits. So this isn't a major risk, but it is something to watch as things are still tight.
The other concern here is that it costs Kodiak around $10 million to drill a Bakken well. That's a bit on the high side, especially when top Bakken producer Continental Resources (NYSE:CLR) can drill an ECO-pad well for around $8.5 million. Continental has plans to get its well costs down even further in the future. Kodiak has the same plans, and its making some headway, but it still has a way to go to get there.
While it's hard to put a price tag on growth, Kodiak is trading at a lofty 20 times earnings. Though we do need to keep in mind that the company is expected to grow those earnings by 30% annually over the next couple of years. So, while the company is not a screaming bargain, its not grossly overvalued given its growth projections.
When you add it all up, the risks are that the company doesn't hit its growth targets, or that it overspends to get to them. Given what happened at both SandRidge and Chesapeake, it is worrisome to see the company tapping into its credit line once again to pay for its drilling program. That adds a layer of risk that might not sit well with some investors; though, if the company is successful, those risks could pay off big time in the future.