One of the dangers of being a fast-growing company is that you try to grow faster than what your earnings dictate you can do. In the case of Kodiak Oil and Gas (NYSE: KOG), some of its recent numbers may suggest that it might be an candidate for overreaching. Let's look at the numbers from the most recent quarter and what it needs to do going forward to avoid this fate.
Source: Chesapeake Energy Media Relations
Trouble under the surface of strong results?
It's hard to deny Kodiak's ability to grow production. Between 2010 and 2012, the company was able to grow production by more than tenfold, and its projections for 2013 are expected to be tenfold greater than what they were in 2011. It also helps that all of the company's holdings are in one of the premier shale oil plays in the U.S., the Bakken. Currently, the company is producing a mix of about 94% crude oil, which makes for much more attractive economics today, considering the prices of West Texas Intermediate crude and Henry Hub natural gas spot prices.
That high percentage of oil has translated into a staggering cash margin of $60 per barrel. That kind of cash generation puts them far ahead of other Bakken-centric producers such as Whiting Petroleum (WLL +0.00%) and Continental Resources (CLR +0.00%), which have cash margins of $52 and $47 per barrel produced, respectively.
As good as some of those numbers are, there is one issue that could come back to bite Kodiak. Currently, its 2013 capital expenditure budget is set for $1 billion. To put that into context, the company is expected to generate only about $897 million in revenue this year. After expenses, that translates to about $688 million in EBITDA. So the only way the company will be able to fund this ambitious capital expenditure program is through debt financing.
So far this year, Kodiak has issued about $336 million in net debt financing, a large chunk of which is for its $660 million acquisition of private company Liberty Resources. To meet that capital expenditure budget, it's very likely that the company will need to continue to issue debt. The company currently has a debt-to-capital ratio of 56.6%, which is already higher than both Continental and Whiting -- 54.5% and 37.9%, respectively -- and is expected to grow by the end of the year.
Shadows of Chesapeake?
Whenever we talk about oil and gas companies that are getting into problems with debt, the knee-jerk reaction is to compare it with what happened with Chesapeake Energy (CHK +0.00%). By now we know the story of Cheaspeake: It bought up acreage like a drunken sailor on shore leave (no offense to sailors intended), and its ability to produce cash didn't cover its debt or lease obligations, which ultimately has led to a massive sell-off of assets. Today, after more than $15 billion in asset sales in the past two years, the company's most recent net income was 50% less than what it was a year ago, but there are signs that the company is starting to turn it around.
There is one distinct difference between the debt problem with Chesapeake and what we're seeing with Kodiak today. Most of the capital that Kodiak has raised so far, the Liberty acquisitionnot withstanding, has been going going directly into drilling operations versus large land grabs. The company will thus realize the benefits from that capital expenditure much faster. With a total of 100 wells coming online this year, there's a pretty good chance that there will be a big jump in revenue that will help to cover those additional interest expenses.
What a Fool believes
Very rarely can a fast-growing company like Kodiak cover its capital expenditures with working capital alone, especially with the high costs of drilling in the Bakken region. At the same time, though, the company does need to be cautious that it doesn't try to expand faster than what it can realistically achieve. So far, the company has performed well in growing production. But with whispers that the company is looking at making another acquisition soon, which could put further strain on the company's debt load, investors need to be careful that it can maintain this whirlwind pace to meet its lofty expectations.
