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Peter F. Way, Blockdesk (711 clicks)
ETF investing, CFA, portfolio strategy, long/short equity
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Heard of "fracking"? That's the extraction technology now all the rage in oilfields from North Dakota to South Texas. DXP Enterprises (DXPE)-produced equipment is key to the process.

Fracking involves fracturing shale beds that lie as much as a mile below mid-USA states' surfaces by injecting high-pressure water into these geologic structures that cover hundreds of square miles. That opens up crevices between shale layers, allowing entrapped oil and natural gas to flow up out the access well.

The extraction economics are quite attractive. Conventional oil & gas drilling sinks shafts vertically down into geologic domes or fault structures where payoff zone heights are measured in inches and feet, to recover relatively small amounts of hydrocarbons. When the structure is pumped dry, or nearly so, another well has to be drilled, a step-out, to reach other pay structures. Drilling is expensive.

In fracking extractions, one well is drilled vertically to reach the shale bed. Then it is whipstocked to travel horizontally along the pay-zone. These structures are measured in square yards to square miles, not inches to feet.

The results have been startling. Whereas natural gas had been previously encountered in association with the intended crude oil target, it sometimes produced surprising amounts of volume, creating unpredictable, temporary over-supply periods, referred to in the oil patch as "gas bubbles."

Because of their unreliable supply presence, long-term consumption contracts could not be negotiated, distribution supply pipelines could not be financed, and the bubble's glut would be largely shut-in until local demand finally used it up, always at severely depressed prices, compared to crude or refined oil products.

But now the costs of producing natural gas from fracking these huge, extensive deposits make them economic to be developed just on their own potential payout, even at relatively low "nat gas" prices.

Their logical markets are electrical power-generating utilities, now employing cheap "dirty" coal that puts particulate matter into the air, even when expensive "scrubbing" units are employed on plant stacks. Natural gas supplies now are reliably assured, and at costs that can lock in long-term contract prices that will support supply pipeline financing. And no particulate matter results in burning, so natgas has a further price advantage over coal, in addition to its "green" ecology-political advantage.

Then the second surprise drives home the guarantee of expanded fracking activity: Instead of "conventional" oil production getting a paystream boost from associated natural gas, now the "unconventional extraction" method's targeted nat gas paystream is goosed significantly by associated crude oil and other hydrocarbon liquids, in far greater proportions than had ever been anticipated. It is now common that in good fracking operations the liquids are more than half of the production paystream value.

With continued improvements likely in fracking practices, it is highly probable that the US can become energy independent within another decade, given the extensive deposits already identified, and further possibilities not yet proven out. This is discussed at length in this article.

All this promises an exciting and growing demand for high-pressure pumps for water injection, made and sold by DXP Enterprises (DXPE).

Besides the assured demand for one of their principal product lines, several other circumstances make DXPE stock a very exciting investment prospect. Third quarter return on invested capital was 28.8% after taxes. Year-over-year increases in store sales were above +50%. Details are available, if desired, in DXP's 3rd quarter 2012 on-line review with stockholders and analysts here.

The stock currently trades at a 14-15 P/E ratio, with a PEG ratio of only 0.5 or less. Next five-year earnings growth is estimated at 28% per year. Industry PEG ratio norms, by comparison, are at 1.0.

Only five analysts cover the company, compared to 16 for Chesapeake Energy (CHK), now the nation's largest natgas producer by fracking methods. Management and its interests own 31% of DXPE stock, compared to 8% at CHK. The floating stock of CHK is 76% owned by mutual funds and 545 investment institutions, while as yet only 60% of DXPE is owned by mutual funds and 143 institutions.

The message is that demand for DXPE stock has lots of growing room. How about its supply?

Uh-oh! This is a market-cap of only $630 million. Its daily average trading volume is 65,000 shares, or just under $3 million of value. But there is about 10% of the company's stock not yet in the hands of funds and institutions. That is likely to be an accumulation target for bargain-hunting professional investment organizations that can be patient, small trade, acquirers.

Even despite careful buying programs, the stock's price is bound to climb further. Its one-year target among interested analysts is $58+, a +31% gain.

The more aggressive, shorter-term view of market-makers, inferred from the behavioral analysis of their self-protective hedging actions, is a sell target of $49+, or up 11%, twice as much upside as down. That seems likely to be reached, since in the 2-3 month holding period following such forecasts its price has been higher 7 days out of every 8, by an average of +21%.

Here is what the recent history of their price range forecasts (the vertical lines surrounding each day's heavy-dot market price) looks like:

(click to enlarge)

In the past 2-3 years that kind of upside-favoring balance has occurred over 16% of the time, so it is not a rare appraisal. But out of the 102 days where it has been present, buys restricted to a 2-month holding limit, and aimed at sell targets of the top of their forecast range of the day, have been profitable in all but three days. That's 97% of the time.

The average gain from the holding-time-restricted program, for all 102 forecast days, including the loss days, was +15%. That was achieved in average holding periods of 24 market days, a day short of 5 weeks. When looked at on an annual basis, that is a rate of over +300%.

The average maximum drawdowns during each of those 102 experiences was only -4%.

That history from current forecast level priors ranks DXPE's reward-to-risk tradeoff experiences at better than 99% of all other stocks and ETFs, similarly measured from their current outlooks.

In short, here is a small-cap stock, well-owned by management and by institutions, that is directly and actively in the path of an overwhelming change of direction by one of the nation's largest and most important industries, selling at cheap PEG proportions and viewed by market professionals as an odds-on bet to achieve short-term gains at a triple-digit annual rate, as well as a one-year likely gain of better than three times the traditionally-viewed long-term tend of stock price gains. Having a history of minor drawdowns from cost, this stock should be viewed as a highly attractive buy for individual investors.

Source: Levi Strauss Sold Pants For Gold Diggers, DXP Sells Pumps For Digging Black Gold