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Introduction

I was late to the Kodiak Oil & Gas (KOG) party. Heck, I still am. My invitation must have been lost in the mail, because everyone knows I enjoy a good E&P party as much as the next O&G investor. Well, the good news keeps rolling in and the equity keeps rising. Ergo, I wonder: is it too late? Is the party over?

Kodiak Oil & Gas is the apple of many domestic E&P investors' eyes and, frankly, I can't blame them: ~50% in under six months always feels good.

Thus, the query remains: if one is not a shareholder, is the equity still a buy? After the meteoric rise of the past few months, I err on the side of caution. It is important to determine 1) what kind of growth expectations are priced into the equity at current value; and 2) how likely is the company to meet and/or exceed those expectations. This article will serve as a look behind the veil for investors who also had their invitation lost in the mail.

The Context

One mustn't work hard to find recent stories about Kodiak and nearly all of them are positive. Let's go over the "greatest hits":

  1. Kodiak buys more acreage in the Bakken.
  2. Kodiak presents at the Barclays CEO Energy-Power conference and provides updated guidance.
  3. Kodiak is mentioned as a possible acquisition target.

There are plenty of recaps of these events, and I'm not going to bother examining them; rather, I'm interested in what they imply for the equity and its value--present and future.

The confluence of these positive events are evident in the ~50% upswing since May of this year. Fantastic news all around, but as the valuation continues to increase, simply meeting such expectations may not sufficiently level the value.

Yup, It's Overvalued

As is often the case for aspiring E&P growth stories, KOG is trading at a substantial premium. At this stage, I'm not surprised or concerned. I'm curious.

Here's the overview:

Current Price12.81
Market Cap3.40 B
Shares Outstanding265.57 M
Enterprise Value4.834 B
Price/Sales (ttm)5.73
Price/Book (mrq)3.01

The price/sales ratio sticks out, and I am impelled to start there: paying nearly $6.00 for every $1.00 of profit is a nice premium.

We are using a TTM value for the denominator, therefore it is only reasonable to look at sales growth over that time segment.

KOG Revenue Per Share Quarterly Chart

KOG Revenue Per Share Quarterly data by YCharts

Indeed, revenue per share has steadily increased over the past twelve months, approximately +100%. Let's do some math:

{P/S} = Price per share / Revenue per share (annualized)

So if we take 2Q13 RPS @ $.6475 the annualized value is $2.59. Using the current price of 12.81 the P/S is 4.95--an improvement, but not much.

Let's reframe the question: what kind of RPS do I need to get the P/S I want? Let's say I want 3. At current per share basis I need an annualized RPS of 4.27, or 1.0675 quarterly. That is about ~65% above the 2Q13 value. Last year RPS improved ~50% from 2Q12 to 4Q12. However, KOG is only up ~4% QoQ (1Q13:2Q13). That places a heavy burden on the third and fourth quarter to maintain the impressive revenue growth.

Like all good E&P companies, KOG is taking on debt. The annualized cash flow looks like this:

YearCash FlowCAPEX
201010,315200,009
201153,913590,749
2012272,6791,348,078

The most recent guidance has FY13 with a ~1B capex budget. Here's this year's cash flow so far:

QuarterCash FlowCAPEX
1Q13114,573279,207
2Q13118,331248,125
Total232,904527,332

That leaves ~$500MM in capex for the remainder of the fiscal year. It would seem cash flow won't be positive for the year. According to this data KOG currently has ~$500MM it can draw on its credit revolver.

One way or another, KOG will be able to fund capex for FY13. While I can't speak on how much liquidity they want or need at this point, I wouldn't think they would want to maximize their revolver. The company naturally wants to be cash flow positive, and that needs to occur soon to avoid further debt offerings.

The Black Stuff

All this talk of revenue and no talk of oil. That is where the money comes from for KOG, and its high time to consider what kind of flow and reserves we are talking about.

Enterprise Value4.834 B
Proved Reserves144 MMBOE (86% oil)
Flowing Barrels per Day37,000 (most recent)
EV/PR34.0
EV/BOEPD130,650

Note that if we use the BOEPD figure including all KOG properties and working interest, which is more like ~50,000, the EV/BOEPD is ~97,000.

There has been pretty consistent growth in KOG's flow and reserve figures. Let's consider the annual change in both departments:

  • Annual flow delta: 168% (compounded)
  • Annual reserve delta: 169% (compounded)

The following chart shows the corresponding values one year from now if those growth rates are sustained. Notice that enterprise value remains the same--I am forecasting the value of future oil growth at today's valuation.

Enterprise Value4.834 B
Proved Reserves243.36 MMBOE
Flowing Barrels per Day62,160
EV/PR19.86
EV/BOEPD77,767

It seems that the predicted flowing figure is realistic and likely to maintain. Here's why:

  • 1Q and 2Q combined avg BOEPD is 22,450 BOEPD,
  • BOEPD is now in the mid 30's,
  • Full year guidance is given at 30-34, with 30 being the likely value,
  • To reach a BOEPD average figure of 30,000 for the year, the second half of the fiscal year will need to average 37,550 BOEPD,
  • Let's say the exit rate for 3Q13 is 38,000. The exit rate for 2Q13 was 34,000. That yields 36,000 BOEPD average for 3Q13...
  • ... which means the 4Q13 value will need to be 39,100 BOEPD...
  • ... which mathematically harmonizes excellently with managments guidance of a FY13 exit rate north of 40,000 (42,000, using my numbers here).

Therefore, using the delta growth figure from above, suggests a FY14 exit rate of 63,504-77,616.

What's in a Number?

After writing at some length of flowing and reserve figures and predicting their future value, it is now worth considering why these numbers matter and what they entail. Flow and reserves are the meat and potatoes of an E&P companies value, so let's consider some recent Bakken transactions:

  1. Consider this recent Bakken acquisition by Oasis Petroleum (OAS). The $1.52B dollar deal will increase daily BOE production by between 9 and 10,000, which averages to a ~$60,000 per flowing barrel deal.
  2. Whiting Petroleum (WLL) recently made a ~$260 million dollar Bakken purchase. The acreage did ~2,400 BOEPD in August, which implies a 108,333 per flowing barrel price tag. WLL estimated the reserves at 17.1 MMBOE, implying a 15.20 per reserve barrel price tag.
  3. Kodiak itself acquired Bakken acreage earlier this year for $660 million. At time of purchase BOEPD was around 5,700. A rather undeveloped parcel, that yields a $/BOEPD of 115,800.

Too Expensive for a (Profitable) M&A/PtP Buyout

Kodiak currently commands a ~$15,000/flowing barrel premium over the most expensive recent Bakken transaction. As the subtitle says, the valuation is simply too rich for a buyout to be profitable. However, that's in the short run, as in right now. Notice the italics. If reserve and flows continue to grow at historic rates, here's what a buyout might look like a year from now:

Value BasisKOG Price TagProfit Over CV
75,769 (low)4.8 B($34 mil)
94,711 (mean)5.8 B$1 bil
113,653 (high)7.1 B$2.3 bil

Here are the implications for shareholders:

Value RangeCurrent PriceSell Price
Low12.8112.68
Mean12.8116.58
High12.8121.47

Here's an alternate possibility: let's presume buyouts aren't looking good a year from now. Let's also assume that KOG is maintaining its current premium, which is over $15,000 per flowing barrel over my high value basis. Returning to my oil projection figures from earlier, that means a 3.3 billion increase over the current value, which would generate around $12.43 per share, yielding a share value of $25.24.

Is the Glass Rose Colored?

Three of my four projections are rather rosey for KOG, and the not-so-rosey projection is not-so-relevant--and, in case you're wondering, it is less relevant because it means KOG sells at a loss over current value.

There are negative catalysts in the future, and here I am thinking about liquidity. The revolver will continue to be drawn down and the $600+ mil acquisition earlier this year certainly didn't help the short term cash situation. Consider that KOG's cash flow is still ~50% of capex per quarter and there could be some liquidity issues. Financing won't be a problem; at least, it won't be a problem in terms of getting the financing. Dilution won't please shareholders, but nor will more debt. I won't prognosticate on this issue, but it is a definite card in the deck. For short term traders it is a concern, for long term holders I wouldn't be concerned.

I'm not brushing debt concerns under the table. Let's say KOG burns its revolver into the end of the year and wants $1B of liquidity. It offers them in senior debt notes and increases long term debt, interest included, by $1.1B. What that does is this: it pushes buyout profitability slightly further down the timeline, little else. While it will likely provide a dip in the stock price, it is 1) an uncertain offering and 2) may not lower the share-price-at-debt-offering below the current share price. Therefore, I maintain that this isn't a concern for the long term holder. Lastly, I would expect KOG to be cash flow positive by the end of FY14, which lowers my debt concerns further yet.

Conclusion

A new investor won't be boasting about a ten-bagger with this equity, but I foresee a comfortable and well defined money making machine in the beloved Bakken shale formation. With near highest in class operating margins and remarkable production and reserve growth, I think KOG has plenty of profit ahead of it. My calculations suggest a possible 100% return in a years worth of time with little downside risk.

Personal Disclaimer: I am not an investment advisor and therefore this article is not investment advice. This article mentions options trading which is considered speculative. Therefore, individual research is encouraged before engaging in any transactions. All data and numbers comes from sources I believe to be trustworthy; however, transposition, calculation and other errors are always possible. The author cannot and will not be held accountable for any such errors contained herein.

Additional Disclaimer: The author may initiate long and/or short positions in all equities mentioned, including: KOG, OAS, WLL. These positions may initiate before the article is submitted or published.

Source: Kodiak Oil & Gas: Current Valuation Too Rich For Profitable M&A/Public-To-Private Buyout

Additional disclosure: I have no positions in any stocks mentioned, but may initiate a short or a long position in KOG over the next 72 hours. Said position may materialize before publication.