Off Shore's Loss is On Shore's Gain

Our first question comes from Byron:

I have 1000 shares of LEI and was wondering if you think this small energy company is a good investment or might be a buyout candidate? It has been going up pretty good lately and I am trying to decide whether to hold for greater gains or cash in.  If it might be a take-over target, I might hold it for a while longer. What do you think?

For those not familiar with Lucas Energy, Inc. (AMEX: LEI), it’s a small oil and gas company operating in

Southern Texas. The firm is acquiring land in the Austin Chalk and Eagle Ford shale formations and then revitalizing the old wells - in addition to drilling new laterals. Shale gas is rapidly gaining popularity in the U.S. and is expected to account for over 20% of domestic gas production over the next decade. Lucas Energy has had a nice run buying up wells abandoned during the commodity bust of the 90’s and has built up 1.5 million barrels of provable reserves.

The firm’s stock price has climbed 250% since mid-April, so it seems Byron has done all right for himself.

Now that we’re all more or less acquainted with the firm, let me get to the meat of Byron’s question: is Lucas Energy a take-over target?

On the one hand, oil giants like Conoco Phillips (NYSE: COP) have huge stakes in Eagle Ford, and those companies without Eagle Ford properties are looking to get in. The granite wash at Eagle Ford has high liquid content, and oil and natural gas liquids are more valuable than natural gas. Lucas also has a tiny market cap, only $30 million, so none of the big players would break a sweat acquiring the firm.

At the same time, Lucas Energy is all about turning other oil producer’s trash into its treasure. For the most part, it’s buying up land abandoned by the big players and using its expertise to make the land profitable again. I’m not sure how valuable these second-hand land assets are to an acquirer, and would think they are relatively small potatoes at this point. That said, there is potential for consolidation in the small cap oil and gas exploration space, so a merger or joint venture is probably more likely than an all out takeover of Lucas Energy.

Overall, I think small-cap on-shore oil and gas producers are a good place to park some money right now. In the wake of the BP (NYSE: BP) disaster, off-shore’s loss is going to be on-shore’s gain. And from some cursory research, Lucas Energy seems to have momentum and shares could see upside whether or not the company is acquired.

But bear in mind the stock is hugely volatile, and shares have shot up lately. If I were to speculate here, I would be sure to average in, and would look for a pullback to add more. A drop of 50 percent is definitely not out of the question. If I was already in like Byron, I would probably sit tight, or sell enough shares to get my original investment out - and just let my profit ride.

From a fundamental perspective, the company exhibits symptoms of a fledgling company - it struggles to consistently make a profit. There is also the constant risk of shareholder dilution if this company wants to raise capital. It recently reported it is bank debt free, which means that it would most likely be looking to acquire future properties by issuing stock, or at the very least exchanging an equity stake to enter a joint venture with another oil and gas exploration company.

***Right now, I’m buying into Bakken Oil. The Bakken Oil field in North Dakota has billions of barrels of black gold, and small “wildcatter” drillers are snapping up drilling rights and enjoying oil profits not seen in the U.S. for years. One small $4 company I discovered has 11 working wells, and three more on the way. This company's $0.03 a share loss in 2009 will be a $0.14 a share profit in 2010 and a $0.38 a share profit in 2011. I think you'll agree that's phenomenal profit growth. It's easy to see how this stock can double in price. To learn more about this company, click here.

Our next suggestion comes from Sidney:

Think India.

Short and sweet, I like it. Sidney’s words of wisdom come in response to my article International Getaways for your Capital. In the article, I discuss country-tracking Exchange-Traded Funds (ETF) that I’m interested in - namely those in Brazil and Vietnam. I excluded India, along with a host of other great investment opportunities - pretty much due to space constraints.

But Sidney is correct, the world’s largest democracy is growing at an attractive 8% annual rate, and deserves a bit of ink spilled to discuss it. PowerShares India Portfolio (NYSE: PIN) and WisdomTree India Earnings Fund (NYSE: EPI) are two ETF’s tracking the Indian economy. Both funds have similar holdings, and understandably track each other closely. YTD, the funds have been essentially flat, not a terrible result considering the overall sluggishness of the market.

One concern I have with investing in India right now is inflation. Consumer prices in India rose 14.9% in March, the biggest increase in the G-20. Inflation is a natural companion to such robust growth, but could pose serious problems for Indian equities moving forward. Good call Sidney - let's keep India on our radar as well.

My article last week was intended to encourage you all to check out some of the great opportunities popping up abroad, and India certainly deserves consideration.

Keep sending questions, comments, stock picks, or whatever else you’d like to say to editorial@smallcapinvestor.com.

Have a great weekend.