The Rise and Fall of Oil Prices
We're visiting Colombia this Monday to look under the hood of Houston American Energy Group (Nasdaq: HUSA), a stock that has run 300% since Small Cap Investor Daily reader Bill H. began watching it in July. This $220 market-cap company owns a stake in several Colombian oil concessions and is one of a small number of U.S. listed small-cap stocks with exposure to the emerging economy. In last Friday's issue of Small Cap Investor Daily, I gave you a brief overview of Colombia, and outlined some of the reasons we're watching the country for potential small-cap profit opportunities.
Colombia's economy had been taking off in the 21st century, but like many countries, its economy faltered in 2008 and 2009. Despite the challenging times, the transformation to a more safe, and open, economy is still intact and foreign capital continues to find a home in Colombia. The country is rich in natural resources and agricultural goods, including coal, gold, sugar, fruits, and coffee. But our interests today lie in Colombia's vast oil resources that make Houston American an interesting company for small-cap investors.
While Houston American has operations in Colombia, Louisiana, and Texas, the lion's share of revenues are coming out of Latin America. In the first three quarters of 2009, revenues from Colombia totaled $3.87 million, or 97% of total revenues.
Last Wednesday, top energy officials in the country said that Colombia could add up to six billion barrels of oil to its reserves over the next decade, although the official target is for a more moderate 4 billion barrels. Either way, foreign investment, particularly from Chinese and Canadian firms, is flowing in.Colombia's National Hydrocarbons Agency (ANH) is set to auction 198 oil and gas exploration blocks this coming June, which is expected to result in 60 new licenses. Considering that only 70 have been issued since 2004, this would represent an 86% increase. To get a piece of the growing pie, Houston American has become a shareholder of Texas based private firm, Hupecol, LLC. Hupecol operates oil wells in Colombia and has an office in Bogota.
Just like Colombia faced significant challenges in 2008 and 2009, Houston America also hit a few bumps in the road to growth. First, Hupecol sold the Caracara property in June of 2008. Oil from this property totaled 49% of Houston American's production in the first three months of 2008. This sale left a gap of nearly 30,000 barrels and decreased operating revenue by $3 million. This was a significant event, even thought the company received $10.1 million on the sale.
Also, Hupecol shut down production in 2009 as the price of oil and natural gas plummeted. As a result, from February 12 to April 5 of 2009, Houston recorded no revenues from Colombia whatsoever.
The effect of decreasing prices and lower production on 2009 operating revenues was not good for the company, or its shareholders. For the first three quarters of 2009 as compared to 2008, average price for a barrel of oil declined from $97.65 to $55.89. Also, total producing wells decreased from 39 to 23, and oil and gas revenues decreased 53.8% to $3.98 million. These factors, and the broad sell-off in stocks, kept the company's stock around the $2 price level, a dramatic 82% decrease from the June 2008 high of $10.79.
Naturally, the only way to make up for lost time was to drill, produce more oil, and try to get back on track. In the first three quarters of 2009 Houston American drilled 12 new wells in Colombia and as of September 20, 2009 was producing on 6 of them – a pretty solid 50% drilling success rate. The company also re-completed one domestic well in the U.S.
The company's no debt capital structure and strategy to form partnerships as a way to access concessions has also helped it to bounce back, without a lot of financial risk. As of the end of the last quarter, Huston American is sitting on $4.7 million in cash, has working capital of $6.8 million, and a mere $270,000 in long-term debt.
The company turned a minimal profit the last two quarters, and basically broke even with cash flow from operations of $53,000 in the last quarter. Analysts are expecting the company to lose $0.03 per share in 2009, so attempting to value the company on a current PE basis is useless. But expectations of $0.15 per share in 2010 and a $7.67 stock price mean the company is trading at 51-times forward earnings, and has a price to sales ratio of 37. As such, Houston American is expensive by the most basic valuation measures.
By comparison, Ecopetrol (NYSE: EC) the Colombian state owned oil company (its market cap is $49 billion) is trading at a mere 14.3-times forward earnings and has a 3.4 times price to sales ratio. Granted, its prospects for growth are not as great as those for Houston American and it has more debt, but still the comparisons indicate to me that Houston American shares are at pretty lofty levels right here.
That said, Houston American's stock is compelling, even if it's too high at the moment. This is especially true if the company is able to grow its presence in Colombia. The potential for big things in the future is there, but so are the risks. If Hupecol were to sell additional concessions like it did with Caracera in 2008, Houston American might find it has less of a foothold in Colombia than it wants. That's the downside to not owning its own properties and if Hupecol sells, shareholders could have a tough pill to swallow.
However, Hupecol could stand pat and Houston American could continue to build partnership and gain lease holds as it works its way through 2010. Getting in on the new licenses to be issued in June 2010 would be huge.
The bottom line for Houston American is this: I'm not a buyer of shares here, but I'm definitely watching the company. The stock has run 300% since July 1 2009, a nice return. But given that the market has been volatile lately, it's not the best time to jump in on high-flying stocks, and Houston American is definitely flying high right now. But behind the expensive stock is a company with potentially great prospects in a country that is rapidly growing its oil and gas industry.
Houston American will be reporting the week of March 15th and reviewing full-year 2009 results will be one of my top priorities. I'll let you know what I think of this company moving forward. For now, let's be content to watch the story unfold.
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