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Executive Summary

Oasis Petroleum (OAS) is a relatively young mid-sized oil company that is the largest pure-play on the Williston Basin, which includes the Bakken and Three Forks formations in North Dakota and Montana. The stock trades at a significant discount to its peers, based upon its high growth rate, accomplished by the drill-bit, since going public in 2010. If the Market does not bid the share price significantly higher, another oil company looking for growth will be likely to do so.

Brief History

Oasis was formed in March 2007 by a couple of oilmen who helped build and sell Burlington Resources (BURL) to Conoco Phillips (COP) in 2006. With the financing of well-respected and successful EnCap, Oasis bought exposure in the Williston basin in North Dakota and Montana, and assembled a crack team of hard working and technically creative people, mostly the best-of-the-best from Burlington. Oasis went public in 2010 and has become the largest pure-play oil company in the Williston Basin, which is the poster-child for America's resurgent crude production. OAS is an accomplished and innovative operator in the Williston, successfully drilling hundreds of very productive wells. From going public in 2010, until the recent acquisition, only 500 barrels per day of production have been purchased.

Valuation Basis

Having decades of experience investing in petroleum companies, I have been convinced that actual earnings are irrelevant, but that cash flow and growth in that cash flow are paramount. In fact, measures of cash flow take into consideration almost all of the important operational challenges facing a successful exploration and production (E&P) company:

  1. Production rates and natural production decline rates
  2. Reserves and the characteristics of the petroleum deposits
  3. Drilling, completion and production techniques and related cost
  4. Production mix (NG, NGLs and/or crude) and transportation costs
  5. Hedging costs and commodity prices

If you analyze cash flow per share, rather than gross cash flow, you automatically take into account whether a Management buys growth by issuing shares to buy production. Any company that can attract financing can grow by buying other companies. The best companies are those that can grow by successfully drilling for oil, not buying it. A successful E&P program that produces cash flow growth indicates success in the creation of wealth, as opposed to financial engineering.

I have chosen to compare the operational results of a number of companies to illustrate how undervalued Oasis shares are, even though its share price has tripled from its 2010 IPO price. Here is a quick summary of why I chose to include the specific companies in the comparison.

  • Whiting Petroleum (WLL) is one of the larger producers in the Williston Basin, alongside Oasis, although Whiting has substantial assets and production, elsewhere.
  • SM Energy (SM) has production and assets in a number of hot plays including the Eagle Ford and the Williston.
  • Carizzo Oil and Gas (CRZO) has sought-after lands in the Niobara and Eagle Ford, as well as the Utica and Marcellus shale plays.
  • Pioneer Natural Resources (PXD) has significant positions in the Spraberry field, the Permian Basin and a number of other hot shale plays and is thought by many to be an acquisition target of the Majors.
  • Berry Petroleum (BRY) has some prospects of increasing their production in California if that State, allows more fracking and some low decline production in place. Berry was included because it is the subject of a buyout offer by LINE/LNCO and therefore is an example of "acquisition valuation", which should be at the top of the range for various valuation methods.
  • Linn Energy, LLC (LINE) is included as the acquirer of BRY and as an example of valuation that is driven by the payment of high cash distributions to shareholders. Although some of the other companies pay dividends, the cash used is only a material amount for LINE, which is a MLP, not a corporation. Linn has holdings in a variety of locations, including the Permian and the Williston.

Basic Relative Valuation of Selected Petroleum Companies

Metric

WLL

SM

CRZO

OAS

LINE

BRY

PXD

Share Price

$ 64.98

$ 87.87

$ 42.98

$ 50.99

$ 29.85

$ 50.75

$ 188.29

Market Cap (millions)

$ 7,734

$ 5,724

$ 1,720

$ 4,717

$ 6,083

$ 2,806

$ 23,785

Enterprise Value (EV) (millions)

$ 10,034

$ 7,068

$ 2,832

$ 5,921

$ 13,118

$ 4,959

$ 27,715

EV/share

$ 84.30

$ 108.51

$ 70.76

$ 64.00

$ 64.38

$ 89.70

$ 219.40

Cash Flow (EBITDDAI) (millions)

$ 1,422

$ 854

$ 296

$ 523

$ 1,025

$ 340

$ 1,294

Cash Flow/share

$ 11.95

$ 13.10

$ 7.39

$ 5.65

$ 5.03

$ 6.14

$ 10.24

Share Price:CF/share

5.4

6.7

5.8

9.0

5.9

8.3

18.4

EV/share: CF/share

7.1

8.3

9.6

11.3

12.8

14.6

21.4

Note that Cash Flow (CF) is defined as GAAP Earnings before interest, income taxes, depreciation, depletion, amortization, and impairment charges (EBITDDAI).

As you can see, I have listed the companies according to valuation on the "EV/shares:CF" (Enterprise Value per share divided by Cash Flow per share), on the bottom row of the Table. The EV:CF ratio corrects for different companies using borrowed money to different extents over the years. E&P companies usually spend more than their CF income to drill. Some companies raise the money by selling shares, some by increasing debt, and some do both. Those companies with a lot of debt (LINE, BRY and CRZO) have significantly higher EV to CF compared to Share Price to CF ratio.

In this analysis, Whiting's cash flow garners the lowest market multiple of this group, while Pioneer's cash flow is the most highly valued by the Stock Market. It is logical to guess that this relative valuation has something to do with rumors of a large-premium buyout coming along for PXD or perhaps because companies with higher valuation are growing faster. While I cannot predict specific acquisition bids, I can determine whether relative CF growth accounts for the valuations in these companies. Using their SEC filings for 2010 through 2012, I have calculated the compound annual growth rate (CAGR) of each company's cash flow. I then take CF and divide it by the CAGR ((EV/share: CF )/CAGR) to calculate a PEG ratio for each company. Keep in mind that the lower the PEG number, the lower is the Market Valuation. In other words the market is ignoring the growth of low PEG companies.

PEG RATIO (EV/share)/3yr. EBITDDAI growth

Metric

OAS

CRZO

LINE

WLL

SM

BRY

PXD

Share Price

$ 50.99

$ 42.98

$ 29.85

$ 64.98

$ 87.87

$ 50.75

$ 188.29

3 yr. EBITDDAI CAGR

168%

79%

41%

13%

14%

22%

25%

PEG RATIO

6.7

12.1

31.2

55.2

61.2

64.9

84.7

I have re-sorted the companies and presented the data, based upon PEG ratio, from the most undervalued to the most highly valued by the Market . It seems obvious, given the high values for BRY and PXD that "buyout" offer-related valuation trumps any expected "growth premium" that the logical among us may expect. Based upon the 3 year compound annual growth rate, LINE's faster growth is valued less by the market than its slower growing buyout target, Berry Petroleum; its price artificially pumped up by the buyout offer, which I think of as being too high.

The lower growth rates of SM and WLL suggests a reason why they have the lowest price to CF ratios (presented in the first table), especially compared to Oasis whose growth rate was more than 10 times that of both Whiting and SM Energy.

Carizzo also appears to be significantly undervalued compared to the other companies on the list (other than OAS), given its 79% compound annual cash flow growth rate.

The 3 year PEG value is a direct reflection of the lands at the Company's disposal and the ability of Management to exploit those lands efficiently to maximize cash flow that can be reinvested. Growth in cash flow reduces borrowing and share dilution and allows a company to grow production, reserves, and cash flow, thereby growing shareholder value.

The PEG data (recall that lower PEGs reveal under-valuation) indicate that the growth leader of this group is Oasis Petroleum, by a significant margin. Carrizo's PEG is twice that of Oasis. Berry's is 10 times higher and high-valued Pioneer's PEG is 12 times that of OAS. Oasis' recent report for the third quarter of 2013 revealed that the company is still growing at a high rate. In Q3, Oasis increased its Williston land by 49% to 492,000 acres and increased adjusted EBITDA by 18%, over the second quarter of 2013. That is a 93.88% annualized EBITDA growth rate.

It is a wonder that Oasis, the company with the group's best 3 year record of growth, has the lowest valuation when growth rate becomes part of the analysis. If Stock Valuation is about growth, this is obvious evidence that the Market is at least temporarily making OAS stock a bargain. Perhaps it is because OAS Management tends not to be promotional, letting the numbers speak for themselves. If so, perhaps the current analysis stressing growth in cash flow as a prime determinant of value will help those numbers speak a little louder. Even though the Market can remain illogical for long periods, it is likely to recognize value sooner or later. And if the Market doesn't recognize it, a larger company will make a premium bid to buy Oasis, perhaps triggering a bidding war by putting the company "in play".

Source: Oasis Petroleum: Growth Record Justifies A Significant Share Price Rise