Kodiak Oil and Gas (UNKNOWN:KOG.DL) has grown by leaps and bounds, sending its stock upward. Now is a good time to ask if it is still worth buying at current prices. Kodiak's growing earnings and production are encouraging, but relative to proven reserves the company is pricey.
Overbearing rationality is seldom the primary quality of humans. For better and worse, we are an odd combination of emotion and rationality.
Nowhere is this mix of emotion and rationality more evident than in the stock market. Traditional finance theory only explains a portion of a stock returns. Empirical studies show that momentum along with traditional value metrics tend to provide the best explanation of stock returns. In plain terms this means that investors sometimes buy stocks because of a company's underlying business, but investors also bid up prices due to emotions and herding.
Prices among smaller U.S. exploration and production plays like Kodiak Oil and Gas, Continental Resources (NYSE:CLR), and Halcon Resources (NYSE:HK) are enough reason to double check these companies' numbers. The calamity in Iraq is putting upward pressure on oil prices, but this is not reason to assume that Brent will stay above $110 per barrel forever.
|Company||Proven Reserves (MMBoe, 2013 10-K)||Oil Reserves / Total Reserves (%)||Enterprise Value ($Millions)||Enterprise Value ($) / Boe|
|Kodiak Oil and Gas||167.3||82.6||6,044||36.13|
The valuation challenge
Relative to small and growing E&Ps, Kodiak does not appear too expensive. The kicker comes by looking at how much it makes per barrel of oil equivalent. In the first quarter of 2014, the cost of leases, production taxes, marketing, DD&A, and a number of other production-related expenses worked out to be $54.11 per Boe. Thanks to favorable natural gas pricing, it received $83.93 per Boe in Q1, leaving $29.82 per Boe flowing to Kodiak's coffers.
Paying $36.13 per Boe is pricey considering that Kodiak makes $29.82 per Boe. Kodiak is hard at work cutting well costs, but it is a challenge to find significant productivity gains. From 2012 to the third quarter of 2013, it cut well costs around $2 million. From Q3 2013 to 2014, it expects to cut well costs around $1 million. The good news is that Kodiak expects to drill the same number of net wells in 2014 as it drilled in 2013 at a 7.8% discount.
Kodiak is not the only company in this position. Continental Resources is focused in the Bakken and Oklahoma's SCOOP play. It is trying to shave another $500,000 off its Bakken well costs to bring them down to $7.5 million. By focusing its drilling on the more oil-rich regions, Continental Resources will be able to squeeze out higher margins; but it still deserves a discount relative to Kodiak and Halcon Resources thanks to the lower percentage of oil in its reserves.
The majority of Halcon Resources' acreage is in the Bakken, but it also holds acreage in Texas, Louisiana, and elsewhere. By moving experienced crews from its Texan Halcon acreage to Louisiana's Tuscaloosa Marine shale, it hopes to cut its Tuscaloosa well costs by $2.4 million. Shifting to multi-pad drilling can really help out the bottom line.
Halcon Resources' relative valuation premium is understandable. A large portion of its reserves are oil based, and bringing Louisiana online will give it access to attractive LLS pricing. At the end of the day, Halcon Resources has a little bit more leeway in its valuation because it is still developing its Tuscaloosa Marine shale.
Relative value versus absolute value
In terms of relative value, Kodiak is not too expensive. Compared to Continental, Kodiak's reserves are weighted toward oil, justifying a higher enterprise value/Boe price. At the same time, Kodiak is trading at an EV/Boe price of $36.13, while it brings in $29.82 per Boe after accounting for production, marketing, and other unavoidable costs. It will continue cutting well costs to try to boost productivity, but there is a limit to how much operational improvements can boost Kodiak's bottom line.