A Big Market Drop Makes These Below $8 Oil Stocks Too Cheap To Ignore

Includes: KOG, MHRCQ, VTG
by: Hawkinvest

Market volatility and short-term pullbacks can often distract investors and take their sights off of the mid to long-term potential that a stock offers. The recent volatility that comes from Cyprus, weak jobs data and slower growth in China has caused oil prices to drop slightly and this has also put pressure on many stocks in the oil sector. There was also a recent explosion in Boston which could unfortunately be terrorism. This caused a very sharp decline in the stock market. However, this is a potential buying opportunity since a banking crisis in Cyprus, acts of terrorism or a small decline in oil prices does relatively little to the long-term upside for many small oil sector companies.

The stocks below have relatively high upside potential because of significant growth in production and revenues. Plus, these stocks appear undervalued and trade below $8 per share. Lower-priced, small-cap stocks can experience more volatility and investors who buy on dips can take advantage of this. Smaller companies can have more risks, but also can offer a lot more upside and growth potential.

For example, a major oil company like Exxon (NYSE:XOM) is too big to offer fast growth, and it is really too large to be a takeover target. Exxon shares trade for about 10 times earnings, but few expect this company
to grow rapidly. By contrast, some of the stocks below trade for less than 10 times earnings and offer high growth potential. Another positive is that fast-growing companies can absorb a decline in oil prices because the growth rate in production often exceeds any percentage decline in the price of oil. However, a company like Exxon doesn't have enough production growth to offset a 5% drop in the price of oil so easily. Here are the names to consider in the recent pullback for this sector:

Vantage Drilling Company, Inc. (NYSEMKT:VTG) shares are trading below the 52-week high and could have both short-term rebound potential and even more upside in the long-term. This company had the unfortunate timing of being a relatively new company that was founded in 2007, and then the 2008 financial crisis struck. However, Vantage has managed to survive the financial crisis and other challenges that offshore drillers encountered such as the 2010 moratorium on new drilling in the Gulf of Mexico. After a spate of bad luck that was not Vantage's fault, this company might be on the cusp of a real uptrend in both revenues, profits and the stock price.

Analyst estimates show a consistent trend for potentially rapid growth in earnings over the coming years. If revenues and profits come in as expected, this stock is trading at just over 4 times estimates for 2014. For example, earnings estimates are expected to go from just about 6 cents per share in 2013, to 34 cents in 2014, and to 42 cents in 2015. This growth potential is possible as new drillships are launched which add a substantial amount of new revenues, while operating expenses remain relatively flat. This could be an ideal time to invest in Vantage because it appears to be near an inflection point whereby additional revenues from new drilling ships and contracts will be a gamechanger for the profitability of this company. Plus, as revenues and profits jump, Vantage is more likely to be able to refinance existing debt at lower rates. That could also substantially boost the bottom line. Let's take a closer look at the new drillships that are expected to be launched and add revenues:

Vantage launched the "Titanium Explorer" in the last quarter of 2012 at a rate of $572,000 per day. That is expected to substantially boost financial results in 2013. Revenues are expected to jump even more once the "Tungsten Explorer" is launched in 2014. This new build is also expected to generate hundreds of thousands of dollars each day, and that really adds up. Vantage is expected to engage in contract negotiations for this drillship and it is expected to generate about $641,000 per day in revenue. That would produce additional revenues of roughly $230 million per year. But there is also major revenue growth expected for this year when you look at the fleet status report for Vantage. Some of its jackup rigs are expected to acheive substantially higher daily rates in 2013. For example, the "Emerald Driller" is projected to see average daily rates jump from $130,000 to $156,000 around mid-2013. The "Sapphire Driller" is expected to see rates jump from $120,000 per day to $165,000 per day in the second quarter of 2013 and there are rigs that could contribute to revenue and profit growth.

The company recently filed a lawsuit against BP plc (NYSE:BP) for damages it believes are related to the 2010 Gulf of Mexico oil spill. Vantage states it was damaged by the spill and the subsequent moratorium, and said it had about $265 million in expenses related to this event. BP denied the claim, so Vantage filed suit on April 3, 2013. There seems to be little doubt that the oil spill damaged Vantage and other companies in this industry. I think the most likely scenario is for this case to be settled over time and even if it is just for a fraction of the $265 million, that could potentially result in a substantial recovery for Vantage. For example, with about 300 million shares outstanding, a $60 million settlement could add about 20 cents per share to the bottom line. Even a $30 million settlement would be significant for a stock trading at just over $1.60.

Vantage shares could move higher when the company announces news on the contract negotiations for the "Tungsten Explorer", which it is expected to do in the coming weeks as this drillship is being built. It's also worth noting that Vantage is not tied to the daily swings in the price of oil as some of the other stocks mentioned here. Vantage also engages in long-term contracts that often last for years and this provides a steady revenue base. This lowers downside risks for investors who want exposure to the oil sector without worrying about the daily swings in the price of oil.

With Vantage shares trading for just over $1.60, it might not be long before it makes another run for the 52-week high of just $1.95 in the short-term. However, the longer term upside could be around $4, as earnings are expected to rise to around 40 cents per share after 2013, (based on a multiple of ten times earnings). Therefore, this stock appears to have the most upside out of all the names mentioned here.

Magnum Hunter Resources Corporation (MHR) is a fast growing oil and gas exploration and production company with projects in the Eagle Ford and Marcellus Shale areas. While the company has been rapidly growing production, the consistent profits that some investors have hoped for have yet to arrive. That is primarily because management has been focused on revenue growth. The shorts seem to be focused on this and the fact that the company recently announced it would delay the filing of the annual 10-K report beyond the extended due date of March 18, 2013.

The company said it: "has identified certain material weaknesses in its internal controls over financial reporting in connection with its (I) lack of sufficient qualified personnel to design and manage an effective control environment, (ii) period-end financial reporting processes and (III) share-based compensation. Magnum Hunter has implemented, and continues to implement, measures to address these weaknesses in the future."

These types of issues could create additional risks for investors, however, it is not uncommon for a fast-growing company to experience these kinds of "growing pains". Shorts might be ill-advised to read too much into the lack of consistent profits and the delayed 10-K filing because Magnum Hunter has a management team that includes CEO Gary Evans. He has a history of producing solid returns for shareholders and his last oil company was acquired by Cimarex Energy (NYSE:XEC) for approximately $2.2 billion in 2005. Some investors believe he is positioning Magnum Hunter for rapid growth, which could then lead to profits, and possibly the goal of having this company being bought by a larger firm. If that is the case, shorts have plenty to worry about especially since this stock has made large moves to the upside in the past. If the company files the 10-K with no other issues, investors could view this as a positive upside catalyst. This stock was trading around $4.20 in March but now goes for about $3.30 per share.

According to Shortsqueeze.com, there are about 34.3 million Magnum Hunter shares short. Based on average trading volume of around 4.6 million shares per day, it could take over 7 days worth of volume for shorts to cover. That level of short interest could be enough to trigger a short-squeeze, especially on any better than expected news from the company.

Kodiak Oil and Gas Corp. (NYSE:KOG) shares were trading around $7 in July of last year. Since then, the stock has been in a uptrend and it recently traded for about $9.50. However, in the past few days it has pulled back to less than $8 per share which gives investors another solid buying opportunity.

Kodiak is a high-potential oil stock because it has oil and gas projects in the Bakken Range, Williston and Green River Basins, in the U.S. Rocky Mountains. It also has significant upside potential because the stock appears undervalued and it is growing rapidly. Another upside catalyst could be a takeover and as one Seeking Alpha article points out, a solid case can be made for the shares to be worth about $19 in a takeover. This is based on asset values of other recent deals in this sector.

Kodiak is solidly profitable and this significantly reduces risks for investors. This company is also growing at a fast rate. Numerous new wells are expected to come into production in the next couple of years and that will drive revenue and profit growth. For example, analysts expect Kodiak's revenues to jump from about $840 million in 2013 to around $1.14 billion in 2014. Analyst estimates are for a profit of 71 cents in 2013 and nearly $1 in 2014. That is earnings growth of about 40%, and the stock is only trading at about 11 times 2013 earnings and for just 8 times 2014 earnings estimates. That is too cheap for a company that is growing revenues and profits at strong double-digit rates. Investors should consider taking advantage of the recent pullback in Kodiak for the longer-term potential it holds.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I am long VTG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.