Oil remains the most profitable play (Part Two of Two)
On Thursday, we examined why the oil sector will be one of the most profitable sectors to round out 2008, and gained insight from Jason Votruba, vice president and co-portfolio manager of the UMB Scout Small Cap Fund, and Richard Wyman, vice president and senior oil and gas analyst at Canaccord Adams. Today, Votruba and Wyman name their favorite small-cap oil and gas stock picks.
Wyman favors oil and gas companies with an established land position, which he calls “scalable repeatable growth opportunity.” The analyst has “buy” ratings on ProEx Energy Ltd. (TSX:PXE), a natural gas unconventional player; Pearl Exploration and Production Ltd. (TSV:PXX), a heavy oil player; and Sterling Resources (TSV:SLG), an exploration and production company drilling in the U.K. sector of the North Sea and Romania. Wyman said Sterling is a bit riskier, but has an active drilling program.
Votruba is overweight energy in his portfolio, with energy comprising 20% to 25% of the fund manager’s diversified small-cap fund. This compares with the Russell 2000 (NYSE:IWM), for which energy composes 7%.
Among small-cap oil and gas companies, Votruba recommended oil and gas exploration and production company Swift Energy Company (NYSE:SFY). “[It’s] probably one of my favorite picks right now in the E&P. I see it as more of a lower risk play. It’s involved in lower-risk development, and not doing a lot of wild-cat exploration; it’s on their existing properties.”
Swift Energy has had its obstacles. Investors rebuked the company in the past after management decided to commence operations in New Zealand — a move that boded poorly in retrospect. Management lost credibility with investors as a result, but Votruba thinks the company’s back on track. According to Votruba, Swift Energy has now surpassed both Chevron (NYSE:CVX) and Texaco as the largest oil producer in Louisiana.
However, the company did see production fall in the first quarter on account of production issues. Specifically, Swift began producing new wells that were shut down after pressure issues arose in a handful of the pipelines, which could cause damage to the oil wells. But Votruba says he’s confident Swift will be able to get its wells operating again in 60 to 90 days, and thinks production will climb 30% in the second half of the year.
“With oil prices where they are, I think this is one of the companies that buys floors so they can lock in some of these record oil prices,” Votruba said. “I think you’ll see some nice profits out of this company.”
The company has 134 million barrels of oil-equivalent-proof preserves, “that could expand even higher, but based on the fact that most of that is oil and equivalents, it does command higher prices. Based on that, if you look at natural gas and oil prices at current levels, this company should eventually be worth around $130.”
Votruba also likes Unit Corp. (NYSE:UNT), a hybrid U.S. land driller and exploration and production company. The company focuses most of its drilling efforts on the mid-continent area, the Gulf Coast and along the Rockies. It has roughly 129 rigs, rendering it the fourth-largest U.S. land fleet operator.
Votruba said he expects higher drilling rates, which are at about 18,000, to continue to climb. He also expects higher utilization of rigs, which is currently about 78%, as other companies use Unit’s land rigs for development.
On the exploration and production side, Votruba said he expects the company to realize increased production and see higher prices on gas, as the majority of its production is in gas. He said production will likely be up around 13% this year with significantly higher prices.
“Based on estimates around $10 gas and $100 oil, this should be a $100 stock,” he said. “Obviously prices are a lot higher than that, so I see higher upside. The stock has had a good run, but I still think it’s going to go higher.”
Hornbeck Offshore Services Inc. (NYSE:HOS) is another small-cap name Votruba liked in the offshore oil and gas exploration and production industry. For every $1,000 increase in day rates on the leaser’s oil drilling rigs, $0.30 in earnings is added to the company’s bottom line, according to Votruba. “I think they’re the best in the business,” he said.
Also, as oil has reached new highs, Hornbeck has shrewdly begun to secure longer-term contracts up to six years in duration, compared with its historical three years, to lock in lofty crude oil prices.
“I think this company perhaps has up to $7 per share in earnings power, so there’s some great upside,” said Votruba, who also thinks there’s the potential for a buyout, as Hornbeck’s competitor, Gulfmark Offshore (NYSE:GLF), bought its competitor Rigdon Marine on May 28 at a significantly higher price.
“If our growth does slow down, if the world slips into a recession or depression worldwide, obviously oil is going to take a big plunge,” Votruba said. “I think that’s the only thing that’s going to slow it down.”
