The iShares Russell 2000 ETF (NYSEARCA:IWM) declined from $119.83 on March 4, 2014 to $108.88 on May 15, 2014 (-9.14%) in what most would consider a significant pullback. During that time many of the Russell 2000 stock prices crossed below their 200-day SMAs, including the IWM ETF itself. Several small Permian Basin oil and gas exploration and production companies' stocks did not even cross their 50-day SMAs. They maintained their uptrends. Partly this was due to the strength in oil prices over this period; but in large part it was probably due to the strength and potential of these oil and gas E&P fast growers. Three of these stocks are: Diamondback Energy Inc. (NASDAQ:FANG), Clayton Williams Energy Inc. (NASDAQ:CWEI), and Callon Petroleum Company (NYSE:CPE). It may be worth investors' time to look into these companies more deeply.
The following map shows the Permian Basin, which sits in the western part of Texas and the eastern part of New Mexico.
The Permian Basin has been yielding oil for years; but it has started to yield even more from shale formations in recent years. On top of that the sedimentary rock in the Gulf of Mexico can reach 50,000 feet in thickness. It only reaches about 3,000 feet in thickness near the Atlantic coastline. This may mean that Texas could eventually drill far deeper than the onshore norms of 10,000 to 15,000 feet. Oil and gas companies becoming prominent in the Permian Basin may find themselves with a lot of future development potential available in future years as oil gets more scarce. This is yet another reason to consider investing in companies that are doing well in the Permian Basin now. Naturally small, quickly growing, Permian Basin oil and gas E&P companies are even more interesting to investors.
How good are the results in this new horizontal drilling play? Average EURs (Expected Ultimate Recoveries) in the Wolfcamp A and B range from 600 to 925 MBoe. This is quite respectable and economical. The deeper Wolfcamp C and D (Cline shale) have been less well defined. The table below contains some data for horizontal wells in these zones (as well as some from the Wolfcamp A & B). Readers should especially notice the results from Diamondback Energy, which is one of the stocks this article is trying to review.
Readers should notice that all of the IRR (internal rate of return) and EUR (expected ultimate recovery) numbers are good to great. In sum the wells are not generally as fantastic as many of those in the Eagle Ford shale; but the horizontal Permian wells seem to produce good, consistent results. A well with an EUR of 600 Mboe to 925 Mboe is a well most oilmen would be happy with as long as it is not too expensive. With IRRs of 33% to 60% the above all seem to be highly-profitable drilling plays.
The biggest of the three companies mentioned above at a market cap of $3.70B and an enterprise value of $4.26B is Diamondback Energy Inc. It had over 70,000 pro forma net acres of which 99% are operated as of December 31, 2013. It had pro forma proved reserves of 70.7 MMBoe as of December 31, 2013. These were 67% oil, 15% NGLs, and 18% natural gas. The reserves were 50% proved developed. Notably FANG added another 4,683 net acres in February 2014 in Martin County in the Permian Basin. This brings the total to nearly 75,000 net acres.
FANG is growing quickly. Its production volumes increased 149% year over year in FY2013. Sequentially production increased 30% to 13.6 MBoe/d for Q1 2014. Production is forecast to increase 112% year over year in FY2014. It grew total reserves by 58% year over year in FY2013; and it grew proved developed reserves by 143% year over year. Analysts' next five years EPS growth forecast of 60.00% per annum is fantastic. Further oil was 79% of its production in 2013, which made FANG look very good on a per Boe margin basis compared to its peers. Specifically it had a cash margin of nearly $65/Boe in Q4 2013. The charts below give a good description of just how prolific FANG's growth has been over the last few years.
FANG has identified 3,102 potential drilling locations. It has a lot of room to grow in the multi-layered strata that is the Permian Basin; and that is without considering the many likely strata below the Cline shale. The table below gives estimated EURs for the various strata layers that FANG is drilling in the Permian.
FANG has also been executing on the administrative and engineering sides. The charts below show that it has made continued progress towards decreasing both its overall operating expenses and its lease operating expenses in the last couple of years.
Good management is always a welcome sign.
In Q1 2014 FANG continued its prolific results. It earned $0.48 per diluted share; and that would have been $0.53 per diluted share if the non-cash commodity derivatives loss of $3.3 million was excluded. Q1 2014 EBITDA was $81.3 million. This was up nicely from Q4 2013 EBITDA of $61.8 million. Discretionary cash flow was $79.9 million (or +$1.64 per diluted share). As of March 31, 2014 FANG had $137.0 million drawn on its revolving credit facility and $25.3 million cash on hand. With the increase in the borrowing base of that facility to $450 million, FANG had liquidity of about $338 million as of March 31, 2014.
FANG also had some good to great well results in Q1 2014. The Gridiron N 1H Wolfcamp B well in Midland County, with a 8,785 foot lateral, achieved a 2-stream IP rate of 2,757 Boe/d (91% oil). The ST NW 25-1LS Lower Sprawberry horizontal well in Midland county, with a 4,418 foot lateral, achieved a 24-hour 2-stream IP rate of 1,049 Boe/d (92% oil) on ESP (electric submersible pump). Overall production increased 30% sequentially to 13.6 Mboe/d. Management and shareholders have to be happy.
Clayton Williams Energy Inc. has also been performing well. It has proved reserves of 70 MMBoe (with a PV-10 value of $1.4B). It has 350,000+ net acres and 1,000+ drilling locations identified. About 170,000 net acres were in the Permian Basin; and about 185,000 net acres were in the Giddings Area of East Texas. All of the above statistics are good ones for a company with an enterprise value of $2.07B. On a dollar of enterprise value per Boe of proved reserves basis, CWEI is a much more compelling "value" than FANG. It also has a lot more net acres of prospective oil and gas lands.
In Q4 2013 CWEI had average daily production of 14.9 Mboe. This was up sequentially by 8% over Q3 2013. In Q1 2014 it had average daily production of 15,474 Boe. This was up pro forma year over year by 25% accounting for asset sales. It replaced 526% of 2013 production with new reserves. In Q1 2014 cash flow from operations was $79.3 million. This was up 79% year over year. Net income for Q1 2014 was $11.4 million (or $0.94 per share) versus a net loss of $41.2 million (or $3.39 per share) for Q1 2013.
CWEI sold 95% of its Andrews County Wolfberry assets in April 2013; and it sold all of its interests in certain non-core Austin Chalk/Eagle Ford assets in March 2014. As a result, production data, revenues, and operating costs for Q1 2014 are not comparable exactly to those of Q1 2013. Still the pro forma results cited above were good. Plus CWEI tripled its liquidity from $132 million to $397 million. Primarily its revolver balance was reduced from $460 million to $40 million at the end of 2013. Its total debt was reduced from $810 million to $640 million; and its leverage ratio was reduced from 3.4x to 2.5x. Partly this was done by monetizing its Andrews Wolfberry assets for $215 million. Partly it issued $250 million in senior notes. Partly it monetized its Loving County acreage for $35 million. Further CWEI reduced its capital spending in 2013 from $463 million to $284 million. These acts of good management in controlling its debt should be appreciated by shareholders. Plus shareholders will note that CWEI has more current production in Mboe/d (15.5 Mboe/d for CWEI to 13.6 Mboe/d for FANG), although CWEI is roughly half the enterprise value of FANG ($2.07B for CWEI to $4.26B for FANG). Still FANG appears to be growing much more quickly. Both have their good points.
CWEI has been de-risking its acreage in the Delaware Basin prospective for Wolfcamp A. It has been testing Wolfcamp C. Its peak 30-day average for Reeves County Delaware Basin wells is 680 Boe/d, which is good (this figure is not the one day IP). Its model well profile for these wells is for EURs of 400 Mboe to 700 Mboe (90% liquids) with a cost of $6.5 million to $8.5 million per well and 5,000 to 6,500 foot laterals. Production guidance for the end of 2014 is 16,433 to 17,367 Boe/d. The midpoint of this range is 16,900 Boe/d, which is a 13.4% increase in production year over year. The high-end figure is an increase of 16.6% year over year.
All told CWEI looks like it has good prospective lands. It is growing at a good pace, although not as fast as FANG. Each company seems to have its good points.
Callon Petroleum Company is the smallest of the three in both production and enterprise value. However, it should not be overlooked. One big factor that tells you this is the short interest. It has only 3.20% short interest as a percentage of the float. By comparison CWEI has 5.80% short interest; and FANG has 8.10% short interest. CPE has a market cap of $412.18 million and an enterprise value of $531.76 million. CPE's enterprise value is only about one fourth of CWEI's and one eighth of FANG's. Therefore it should not be surprising that its daily production for Q1 2014 was 4,355 Boe/d. The good news for investors is that this was a 46% increase sequentially. The production was comprised of 85% oil by volume. Further CPE increased its FY2014 production guidance to 5,100-5,400 Boe/d. Its forecast exit rate is nearly 6,000 Boe/d. Its recent growth has been outstanding as the chart below shows.
CPE's two initial Midland County horizontal Wolfcamp B wells produced at average 30-day peak rates of 911 Boe/d and average 50-day peak rates of 820 Boe/d. As you can tell from the table far above, these are good statistics for the Permian Wolfcamp B. The only mildly-discouraging fact is that CPE has only 13,500+ core net acres. This might seem to limit the company; but investors should keep in mind that each prospective area is prospective for 6-7 different strata (zones). The table below illustrates CPE's 585 prospective development locations, which is not a small number.
Multiple zones (strata) can often be accessed from the same pad. This is making drilling cheaper; and it should help to make CPE more profitable. It is engaging in multi-zone PAD development with staggered laterals. Although the number of net acres seems limiting, CPE should be able to buy more as it quickly becomes a bigger company. Plus its experience in the Permian Basin should help it succeed with any new Permian acres it buys.
In sum each of the above companies is likely of interest to investors. Plus they provide a good glimpse of how successful horizontal drilling in the Permian has been (and is likely to be in the future). The charts below of these companies show they have been successful publicly. They provide some direction for possible trades.
The two-year chart of FANG is below:
The slow stochastic sub chart shows that FANG is neither overbought nor oversold. The main chart shows that it is in a strong uptrend. The recent move down in the Russell 2000 has had very little effect on this stock. However, it is not as overpriced as some of the other stocks because it has a 60% next five years EPS growth per annum estimate. This makes the PE of 45.43 and the FPE of 19.62 seem more reasonable than they might otherwise. FANG has an average analysts' recommendation of 2.1 (a buy). It has a CAPS rating of four stars (a buy). Investors can start averaging in if they want to. However, if they are expecting an overall market downturn soon, they may wish to wait to start averaging in. With the relatively strong results and strong ratings agreement, FANG is likely a good buy. Investors still want to try to have good timing.
The two-year chart of CWEI is below:
The slow stochastic sub chart shows that CWEI is oversold. It has gone down with the Russell 2000; but the stock price line has not penetrated CWEI's 50-day SMA. This is a sign of strength. This sign usually means this is a stock investors will want to buy for the longer term. The only question then becomes when to buy the stock?
Investors can start averaging in now. However, CWEI is probably still overpriced with a PE of 54.38 and an FPE of 20.39. The average analysts' recommendation of 2.0 (a buy) is positive; but the CAPS rating of two stars (a sell) is negative. Many probably think that CWEI will get killed if the overall market undergoes a large sell off. That is likely a correct deduction. I believe the CAPS rating is a strong sign of this pervading worry. However, it is not a sign that the company is a bad one. Rather it likely indicates investors' disenchantment with CWEI selling some of its development properties. This means that investors probably want to wait to buy this stock. However, most investors will want to keep it on their watch lists.
The two-year chart of CPE is below:
The slow stochastic sub chart of CPE is near overbought levels. The main chart shows CPE is in a strong uptrend. However, CPE does appear to be far overextended to the upside. This makes one believe that it may correct soon. The PE of 1,455.71 and the FPE of 14.35 reinforce the possibility of a correction; but they indicate that CPE may be a stock investors will want to own longer term. The average analysts' recommendation is 2.2 (a buy). The CAPS rating is three stars (a hold). If investors wait for an overall market correction before buying, CPE will probably perform well for them. Averaging in nearer a market bottom may be a good strategy. Most investors will want this stock on their watch lists.
NOTE: Some of the fundamental financial information above is from Yahoo Finance.
NOTE 2: Investors may wish to look at some of the other stocks operating in the Permian. The Permian could turn out to be an excellent place to prospect for small good growth oil and gas E&P companies. The above three companies are by no means the only possibilities in the play.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FANG over the next 72 hours. 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.