Could ATP Oil & Gas (ATPG) be considered a “screaming buy”? The simple answer is "yes". The current market price for ATPG is $16.27 and, if all goes well, a reasonable 12-month price target could be in the $28 to $32 range, creating a potential gain of between 70% and 100%.
However, the company also comes with offsetting financial and execution risks.
ATP is currently operating cash flow positive at 25 mboe/d production. In the first quarter, management reported ocf of $1.57/share, annualized at $6.28/shr. However, 2011 capital expenditures are slated at $9.50/shr and short-term NPI/override payments amount to an additional $4.25/shr. Combined, the total ocf nut to crack is $13.75/shr. This should equate to production in the 40 - 42 mboe/d range. How is the company going to grow its production from its 1st quarter rate of 25 to 40+?
The company is currently drilling a 3rd well at its Titan production facility and added production should be on-line within the next 60 days. This well should produce at least 7 mboe/d, and is anticipated to be mainly oil. In addition, ATP has a permit to drill a natural gas well that should bring in an additional 3.5 mboe/d, and this project should start shortly. Increased production from already permitted activity should add an additional 10 of the 15 - 17 mboe/d needed to reach 40+.
The company is waiting on a permit to drill the 4th and final well for this round of production at the Titan. Much like the well that is being currently drilled, the 4th well should add about 7 mboe/d. There is an additional natural gas well in the queue that, when permitted and completed, should increase production by an additional 3.5 mboe/d.
With permits in hand turned into production, the company should be reaching 35 mboe/d. When the next two permits are issued, the wells drilled, and the product is on-line, production should reach 45 mboe/d.
With this level of production at current commodity prices, ocf could be in the $13 to $14 range, sufficient to internally fund both cap ex and short-term NPI payments. If share prices trade at a discounted 2.5 times ocf, $11.50 in ocf should equate to a $28 share price and $13 in ocf should equate to a $32 share price.
The risks to achieving this goal are both financial and operational. Unlike some small-cap peers, ATP management has built its business using various debt instruments over equity for growth capital, resulting in high liabilities and a low number of shares outstanding. Internal cash flow, cash in the bank, and additional NPI contracts will allow management to meet their $500 million 2011 cap ex budget, including completion of the two permitted wells. No sane investor would squabble over its high debt levels, but the other side of the coin is equity investors are able to leverage their exposure to the potential of a rapidly expanding production base in a strong commodity market.
Over the next 12 months, investor focus should be on the current two permits and the next two pending wells, their production levels along with any delays in scheduling completion. These next four wells should increase production sufficiently to generate meaningful operating cash flow.
ATPG is not for the faint of heart. Based on its recent trading history, it seems until the investment community is convinced management has succeeded in generating this level of production, share prices will probably not reflect its potential. In other words, it’s what I call a “Missouri Stock” - Show Me the Money. As operating cash flow increases in a stair-step fashion, so will share prices. Based on annualized 1st quarter 2011 results, current share prices are trading at 2.5 times ocf at 25 mboe/d of production. No premium is currently being given for the potential of rapid production growth.
ATPG needs 40+ mboe/d production to become financially viable in the long term. If management achieves this goal with the next four wells, patient shareholders will be amply rewarded. If not, the winners will be the large amount of short bets currently being wagered.
For those that believe the production growth potential is achievable and are willing to take on the speculative risks, a 70% to 100% prospective stock gain should qualify as a “screaming buy”.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.
Disclosure: I am long ATPG and have been a shareholder since 2007