Despite the setback in the price of oil and the oil and gas industry as a whole, plenty of opportunities still exist in the basic materials sector for investors to capitalize off the suppressed valuation these oil and gas companies have to offer. Recently, three companies sparked my interest including, Pacific Coast Oil Trust (ROYT), New Source Energy Partners (NSLP), and Breitburn Energy Partners (BBEP). All three of these companies are attractively priced and offer favorable upside potential both in terms of capital gains and dividend income. Furthermore, the companies are fundamentally sound, and technicals suggest that the current market valuation of these stock present entry points that are quite feasible.
Pacific Coast Oil Trust
Recently formed in 2012 by Pacific Coast Energy Company, ROYT exists as a statutory trust and provides a return to its shareholders' based on the proven reserves in the Underlying Properties it owns interest in. Several of ROYT's properties include onshore oil properties in Santa Maria and Los Angeles, California. The underlying properties with proven reserves are known as developed properties, while the properties with development potential are called remaining properties. Of the developed properties, ROYT receives 80% of the net profits from the sale of oil and natural gas production that takes place on these developed properties. As for the remaining properties, ROYT is in a lucrative position because it's free of any production and development costs on the remaining properties. Here's an overview mapping out ROYT's underlying properties:
(Source: ROYT's September 2013 Investors Presentation)
Since its IPO at $20 per share in May of 2012, ROYT has generated a favorable return on its operating assets, and also has provided shareholders' with a solid return on equity of 25.5%. Despite small decline in its price since going public, its operations are profitable, and its shares are cheap at just 9.34x forward earnings. With a favorable dividend yield of 11.25%, it's hard for institutional investors to turn down this easy dividend income opportunity. As of the most recent filing period, institutional investors hold about 69% of total shares outstanding. Additionally, the four analysts that cover the stock seem to be intrigued as well with a mean price target of $19.25, which cover a horizon of eight to twelve months. Overall, the ROYT's business strategy advantageous, and its proven resources are fully capable of producing a generous level of profitability. Its high dividend yield serves investors with a sufficient amount of downside risk protection, and given its current relative strength index indication is extremely low at 25.80, now is a excellent time to initiate a position.
New Source Energy Partners
NSLP is a MLP focused on the acquisition of oil and natural gas properties in the United States, and through its vertically integrated operations at a conventional resource reservoir in east-central Oklahoma, its shareholders' are positioned to benefit from a considerable amount of value its operations have yet to add. In east-central Oklahoma, NSLP's operations are concentrated on the Hunton Reservoir, which stretches over a vast landscape covering 16mm acres. As of the most recent reporting period, roughly 58% of its resources were denoted as proven as developed reserves, and of that percentage, roughly 76.4% consisted of oil and natural gas liquids. Here's an overview of the Hunton Reservoir:
(Source: NSLP's September 2013 Investor Presentation)
While NSLP is constantly faces the risk involved with operating in an industry that highly competitive in nature, there are high barriers to enter the industry that prevent many firms from being able to compete. Aside from obtaining access to a specific location rich in resources, the next largest barrier for competing firms in capital adequacy. Overall, the industry is very capital intensive, which can be good in bad. Like other firms in the industry, NSLP's cost structure exhibits a high level of fixed costs. This type of cost structure increases financial leverage, which ultimately allows for a larger variation in net income from quarter to quarter. Here's a diagram capturing several other barriers to entry that NSLP's management has set forth:
Institutional ownership remains low for this MLP at only 5%, however recent activity among the insiders make this stock quite attractive. Insiders currently own 33% of total shares outstanding, and majority of these shares were purchased in the last six months. Furthermore, investors still have a chance to initiate a position to obtain an attractive cost basis considering NSLP is only 10% above its 52 week low, and these purchases by insiders occurred well within that time frame. Overall, I think NSLP is attractively priced given its trading at only 12.09x its forward earnings. On the profitability side, its gross margin is considerably high at 73.8%, which is primarily due to the low level of variable costs that are factored into its cost of revenue. Looking eight to twelve months forward, analysts seem optimistic about this stocks ability to perform. Three analysts that cover the stock have a mean price target of $23.50 per share, which is a potential upside of 17.5%, and that excludes the extremely high dividend yield of 10.81%.
Breitburn Energy Partners
BBEP is another MLP with a focus on acquisitons, exploitation, and development of oil and gas properties. BBEP's fixed assets are mainly comprised of properties for the purpose of producing non-crude oil and natural gas. Its properties are scattered throughout the U.S. and include:
- The Los Angeles Basin - California
- The Wind River and Big Horn Basins - central Wyoming
- The Powder River Basin - eastern Wyoming, the
- The Evanston and Green River Basins - southwestern Wyoming
- The Sunnilad Trend - Florida
- The Permian Basin - Texas
- The Antrim Shale - Michigan
- The New Albany Shale - Indiana and Kentucky
Here's an overview mapping the locations listed above as well as figures for daily production and proven reserves:
(Source: BBEP's October 1st 2013 Investor Presentation)
Despite the high level of financial leverage BBEP has from its level of fixed costs, management has adequately diversified this risk through its capital allocation strategy. BBEP has the ability to diversify its fixed cost because of its large portfolio of properties.
(Source: BBEP's October 1st 2013 Investor Presentation)
Right now, BBEP is trading roughly at a 27% discount to its fair value. BBEP's forward P/E suggest its trading at 16.29x its forward earnings, however since the P/E ratio has never been a great measure for this company in particular, I would rather look at projected earnings. As of last month, analysts are estimated between 28%-35% growth in EPS growth over the next year. Furthermore, the 6 month price targets analysts have on its stock price reveal a mean price target of $21.75, which implies a potential near-term upside of 20%. On another positive note, BBEP's holding period returns exhibit a low level of volatility. Using the past two years of its monthly holding period returns, I computed a beta of 0.80, which is extremely low for a company within this industry. To get a since of how low that is, the market has a beta of one. Overall, BBEP fundamentals are sound and it has the potential to serve as a solid investment over the next year. Industry wide, there is a fair amount of risk, but BBEP's high dividend yield offers quite a bit of downside risk protection for investors.
All three company's operations are profitable, and have the ability to generate a return on equity for shareholders'. From a conservative standpoint, the valuation of these companies is attractive, and if you factor in the abnormal dividend yield offered by all three, there's plenty of room for investors to make a profit over the next year.