With all the money printing coming from the Federal Reserve, and with the massive and growing U.S. Government debt levels, investors are increasingly likely to seek assets like oil and gold that cannot be printed by central banks. All of these factors might eventually lead to inflation which could take oil prices much higher in the future. In addition, the European debt crisis seems to be under control and China is now seeing a rebound in economic activity. The U.S. has also seen some stabilization in the job market and improved housing data. All of this is supportive of higher oil prices in the long-run and it might not be long before it is once again trading above $100 per barrel, especially if Middle East tensions or other geopolitical issues arise.
While major oil stocks like Exxon Mobil (XOM) might be suitable for the more conservative part of a portfolio, smaller oil companies that trade in the single digits are often in a much better position to benefit from a jump in oil prices. This is because smaller company stocks tend to move much more (both up and down) on any good or bad news. It is also because small cap stocks tend to offer much higher growth rates when management executes. For example, a number of small oil companies might be able to achieve growth rates of 20% or more for the next few years, but that is just not likely for a major oil company.
Of course, with more potential reward there can be increased risks. While a major oil company can afford to hit a few dud wells in the course of exploration and development, a smaller company may not take it as well financially. However, the small oil company stocks below appear undervalued and well-positioned for a potentially big move to the upside in 2013, especially if oil prices continue to trend higher. Here is a closer look at three undervalued oil stocks that have major growth prospects and even takeover potential in some cases:
U.S. Energy Corp. (USEG) is focused on oil and gas and it has interests in a number of high potential projects. It also has joint ventures with some very well-known and much larger oil companies. This company has a drilling participation agreement with a wholly-owned subsidiary of Brigham Exploration Company ("Brigham") to jointly explore for oil and gas in up to 19,200 gross acres in a portion of Brigham's Rough Rider prospect in North Dakota. Under this agreement, it has working interests in 15 1,280-acre spacing units in Brigham's Rough Rider project. This gives U.S. Energy the rights to drill up to 30 gross wells in the Bakken formation and an additional 30 gross wells in the Three Forks formation, for a total of 60 gross wells. If the spacing is increased to four wells per 1,280 acre spacing unit, the potential number of drilling locations could increase to 120 gross wells. Brigham Exploration was acquired by Norway's largest oil company, Statoil (STO) in 2011, for about $4.4 billion in cash.
U.S. Energy also has a participation agreement with Crimson Exploration Inc. (CXPO) for a Eagle Ford shale oil project in Zavala County, Texas. Based on 120 acre spacing units, there is room for up to 98 gross and 29.6 net Eagle Ford drilling locations. It also has an interest in three natural gas and oil producing wells with PetroQuest (PQ) in Louisiana, as well as other agreements with other oil companies.
The Bakken Range is one of the most oil-rich areas in the world and it has been estimated to have about 24 billion recoverable barrels of oil. That is why companies that have Bakken exposure could be poised for significant long-term gains. In September, 2012, U.S. Energy acquired interests in producing Bakken and Three Forks formation wells in McKenzie, Williams and Mountrail Counties, North Dakota.
U.S. Energy has a solid balance sheet and just about $8.4 million in debt so there appears to be little downside risk in this department. Plus, with joint venture partners in certain projects, this eliminates some of the risks that comes with exploration and development. The primary risk could be on how well management executes the strategic plans.
U.S. Energy shares have drifted lower in 2012 and it seems that the stock is now very undervalued and oversold due to end of the year tax loss selling, putting additional pressure on the stock. This stock appears to have little analyst coverage and it is not as well-known as many other larger oil companies. This can create a major valuation gap or discount which might make sense to take advantage of now.
One analyst firm that does cover this company is Global Hunter Securities which gave this stock a $4.50 price target and an "accumulate" rating. This stock looks very cheap and it trades well below book value, which is $4.50 per share (right where Global Hunter Securities sees the stock price going in the future.) If U.S. Energy assets are worth the book value level of about $4.50 per share, and the stock is trading just below $2, it might even be an attractive takeover target from one of its joint venture or other partners.
Magnum Hunter Resources Corporation (MHR) is a very interesting stock for a number of reasons. For one thing, these shares are sometimes volatile which means quick gains can be made if you buy at the right time. However, this stock also appears to have serious upside potential for the long-term as well. That's because Magnum Hunter has projects located in high-potential areas such as the Eagle Ford and Marcellus Shale ranges.
Another factor to consider here is the management team, led by CEO Gary Evans. He is experienced in this industry and he has a history of making money for shareholders. The last oil company he headed was acquired by Cimarex Energy (XEC) for approximately $2.2 billion in June 2005. If the past is any guide, Mr. Evans could be setting up Magnum Hunter to become a takeover target in the future. In order to develop this company rapidly, he has made some acquisitions in the past couple of years. That has led to a surge in oil production but the big rewards have not come yet as the stock still trades at about 50% below the 52-week high of $7.71 per share.
Analysts expect revenues to jump from about $275 million in 2012, to around $480 million in 2013. That is an increase of over 70%, which is very impressive in a slow to no growth world. While this company has posted losses recently, that is not unusual when it is growing so fast. The balance sheet does have some leverage with about $683 million in debt. Shorts seem to be counting on the lack of consistent profits to continue and that would be one downside risk for longs. However, if profits come sooner than analysts expect, the shares could be headed back to 52-week highs which would be about a double from current levels.
According to Shortsqueeze.com, there are nearly 31.2 million Magnum Hunter shares short. Based on average trading volume of around 3.5 million shares per day, it could take about 9 days worth of volume for shorts to cover. This level of short interest could fuel a rally in early 2013, especially if oil prices keep going up.
Kodiak Oil and Gas Corp. (KOG) shares are a great example of how it can payoff handsomely for investors who buy oil stocks with rebound potential. This stock was trading for about a buck during the 2008 financial crisis and it went on to become a multi-bagger for many investors. That big price decline was also another lesson in how investors and the markets can completely mis-price a stock and take it down to ridiculously low levels.
This company has exposure to the Bakken Range with oil and gas projects in the Williston and Green River Basins in the U.S. Rocky Mountains. Kodiak recently announced a $775 million capital expenditures budget with 75 net wells. It also offered guidance for roughly 29,000 to 31,000 barrels of oil per day as an average for 2013, with an exit rate of about 38,000 to 40,000 barrels of oil per day. As such, Kodiak appears poised for a major revenue and earnings acceleration in 2013. Analysts expect revenues of about $441 million and earnings of 46 cents per share for 2012, and for those numbers to jump to around $841 million and 71 cents respectively for 2013.
Of particular interest, are Kodiak's projects in the Bakken Formation. The Bakken is one of the most oil-rich areas in the world. The CEO of one oil company says he thinks there could be 20 billion barrels of oil in the Bakken. Just since mid-October 2011, the company completed several new wells. Combining an oil rich area with an aggressive drilling program could lead to strong future gains for Kodiak shareholders. Analysts see profits surging from about 21 cents per share in 2011 to around 99 cents for 2012. However, downside risks include management execution as well as the balance sheet which carries about $921 million in debt. Although it has a significant amount of debt, the company has managed this well over the past couple of years.
The stock has been on a steady rise since hitting lows in October, but it still has upside for long-term investors. One recent article even makes a strong case for Kodiak as a takeover target and a valuation level of up to $19 per share. With major growth expected, a reasonable PE ratio, and some takeover potential, buying on dips makes sense now.
Disclosure: I am long MHR.
Additional disclosure: I may buy USEG shares in the next 48 hours.