Invest In African Oil With Kosmos Energy

| About: Kosmos Energy (KOS)

By Matthew Carr

I’m one of those “dividend guys.” I believe dividend stocks should be the foundation of everyone’s portfolio. The reasons are simple: They’re constantly churning along, throwing off income and are typically less volatile than non-dividend paying stocks. Plus, dividend-payers, and those that increase their dividends every year, have completely beaten all sectors of the market over the long term.

So, I’m always on the lookout for solid, dividend-paying companies to buy on dips. That way I can get in at a discount, snag a premium on the dividend yield, and catch the wave back up as the share price normalizes and momentum carries it even higher. But there’s another facet to my strategy…

And that’s to use some of the money spun off by my dividend-payers to invest in more speculative plays when an opportunity comes along. By doing this, I can make those dividends go even further. Then the returns I get from the more speculative plays I roll back into dividend-paying companies. And the whole cycle starts over again.

But as always, my same tenet applies – I want growth, but also value.

The Wild, Wild West

With oil prices securely above $100 per barrel at the moment, there’s still a mad dash on development. There are a lot of regions – both onshore and offshore – that are booming. And one of the parts of the world piquing considerable interest is Africa. Africa is truly a rough and tumble frontier market. There are plenty of resources to develop, but also plenty of political and social instability in some regions.

Northern Africa was the spark of the sweeping Arab Spring movement last year. And we’re all well aware that the governments of Tunisia, Egypt and Libya were overthrown, while Sudan officially separated into two countries. Those northern African countries are continuing to rebuild. And there are a host of ongoing ailments.

On the E&P side, East Africa is home to one of the jewel discoveries in 2011. Mozambique’s Rovuma Basin natural gas finds by Eni (NYSE: E) followed on the heels of huge hits by Anadarko (NYSE: APC).

East Africa oil and natural gas development is still in its infancy really. But Somalia is off limits, Ethiopia’s situation is rocky and Mozambique continues to mend. On the West Coast of Africa, the situation isn’t necessarily more stable. But the oil and gas industry is more mature. At the moment, western African countries – namely Nigeria – produce three million barrels of oil per day.

But here’s the kicker: By 2015, countries along of the Gulf of Guinea are expected to supply one-quarter of the United States’ oil imports.

A Beaten Down Independent Ready to Bounce Back

Early last year, while at lunch with a few other editors and our publisher, the discussion turned to Kosmos Energy (NYSE: KOS). The question was, do you buy Kosmos on its initial public offering (NYSEARCA:IPO) or wait. I was in the camp of the latter. And it goes to show it sometimes pays to be patient. The company’s shares are down nearly 30% since its IPO in May.

Kosmos is an independent E&P company, primarily focusing on under-developed areas in West Africa, and it just recently moved into South America with acreage in Suriname. With the buzz over North American onshore finds, potential in the North Sea and the return of Iraq, Kosmos fell through the cracks. Because of that, shares are now at a discount.

Now, it’s nowhere near as large as the companies it partners with – like Anadarko or Tullow Oil. Or even on the same scale as other international oil companies operating on Africa’s West Coast. But those companies – even though they’re strong and there’s room for their shares to move up – don’t offer the prospect of doubling your money in the next 12 months.

The average analyst consensus on the price target for Kosmos is $18.94 – 44% above what it’s trading at now. The high water mark in analyst consensuses is Credit Suisse, which has a price target of $25 on Kosmos – practically double what it’s currently trading at.

Let’s just stay with the 44% gap between its current price and the average analyst estimate. If we compared that to the S&P 500 stocks with the largest gaps between their current price and analyst estimates, Kosmos would rank fifth.

After the Year of Ghana

Kosmos’ main moneymaker is the Jubilee field, off of Ghana’s coast, where it holds a 25.8% stake. This field is in production, netting the company almost six million barrels of oil last year.

In the deep waters of the Tano Block offshore Ghana, Kosmos is increasing its stake by buying Sabre Oil & Gas Holdings’ share of the projects there. This means, once the deal is completed, Kosmos will hold a 22% stake in the field. And last week, the company announced better-than-expected drilling results in its Tano holdings. These wells are projected to net Kosmos 100 million barrels of oil equivalent (boe).

If we look outside of Kosmos’ Ghana plays, it has 10 more prospects in Cameroon. And this will likely net another 150 million boe.

And finally, there’s Morocco – where Kosmos is the largest deepwater acreage holder with 14 million acres. There are 19 prospects offshore Morocco. The company plans to release pre-drilling estimates for these holdings by the end of the year as it crunches the numbers.

So, there’s a lot of potential here. And we’re sitting at the lower end of the range shares have traded in.

For 2012, Kosmos’ capital expenditure budget is $600 million, with more than 90% of that going to its Ghana assets. The first drilling in Morocco is being eyed for early 2013 while drilling in Suriname will begin in 2014. By the time development in Suriname begins, Kosmos’ revenue is projected to have increased more than 73% over 2011.

I like it. There’s a lot of upside for the dividends we maybe collected from larger oil and gas companies.

At the moment, we’re coming off the pop we saw last Friday – when Kosmos reported better-than-expected drilling results in the deepwater Tano. Oil’s brief slide took the whole oil and gas sector with it. But that’s okay, because instead of paying $14-plus, we’re sitting below $13.25 with Kosmos.

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