Over the past eight months, stock in Kodiak Oil & Gas (NYSE:KOG) enjoyed a dramatic rise, from $4.50 in October 2011 to a high of $10.52 on February 24, before settling to its current level around $9. I think that much of this activity was driven by excitement over the company's rapid expansion in the Bakken shale, where it operates almost exclusively.
This exponential growth over the past few quarters really comes despite, rather than because of, Kodiak's narrow focus on the Bakken, which represents 99.5% (pdf) of its asset base. Kodiak is an interesting small cap oil and gas producer because it is poised to grow even further on the strength of its recent acquisitions and conservative cash strategy (pdf). This, paired with the change of control bond structure for bonds issued last year, has some investors and analysts calling Kodiak a takeover target. As the economy improves, I think Kodiak will be seen by larger-cap energy companies as a strong acquisition if Kodiak can meet its current development targets.
Benefiting From Abnormal Weather Patterns
Kodiak avoided much of the downward price pressures that its competitors suffered from the low gas demand in the U.S., brought on by an unusually mild winter, since Kodiak focuses (pdf) on liquids-rich plays. Considering the location of the Bakken shale in North Dakota and Montana, Kodiak probably benefited from these weather patterns. According to the North Dakota Oil and Gas Division (pdf), this weather pattern of higher temperatures and reduced snowfall led oil and gas production, as well as total operating wells, to new all-time highs in February.
Activities on the Bakken Shale
Kodiak's primary presence is in the Williston basin of the Bakken shale. As of January 2012, it held 157,000 acres in the basin (pdf), compared with 93,000 acres in June 2011, nearly a 60% increase in six months' time due to three significant leasehold acquisitions (pdf) which occurred in June 2011, October 2011, and January 2012.
According to North Dakota's current confidential well list, there are a number of exploratory wells due to release production data this year, with the months between July and October particularly active. Kodiak is currently operating 71 wells confidentially in North Dakota, compared with competitors Chesapeake (NYSE:CHK) with 7, EOG Resources (NYSE:EOG) with 43, Occidental Petroleum (NYSE:OXY) with 37, and Marathon Oil (NYSE:MRO) with 78.
Kodiak has net proved reserves (pdf) of 51,724 mboe, 89% of which is in oil. It is ramping up production from these reserves in a big way. Through all of 2011, Kodiak had (pdf) a total of $261 million in capital expenditures, and it expects to more than double (pdf) this to $585 million in 2012. $550 million of this estimate will be spent on drilling and completion, with a further $25 million earmarked for continuing infrastructure investments and $10 million in acreage acquisitions. At current lease prices, Kodiak will not be able to leverage $10 million dollars into substantial gains in proved reserves, but I believe this is not a negative factor as the small company would do well to focus its limited resources on the acquisitions noted above.
Kodiak indicates (pdf) that it is receiving higher rates of return on 10,000 foot laterals as opposed to 5,000 foot laterals, so that despite fracking's dramatically increased costs at these extended levels, the company believes it is more economical to use the 10,000 foot laterals due to the increased production. As Kodiak admitted (pdf) in its 2011 annual report, the company is still learning how to use these methods while maintaining attractive operating margins.
Kodiak relies (pdf) on third-party oil and gas gathering systems to service most of its producing wells. As a result, the company's sales continue to be limited as it is forced to flare (pdf) production that cannot be serviced by the limited plant capacities available. Bakken producers, including Kodiak, may benefit from the Seaway Pipeline Project, as much of the production from the Bakken and other northern shales currently flows through the hub at Cushing, Oklahoma which cannot meet current demand. The Seaway Pipeline Project will have a capacity of 400,000 bpd by early 2013, a dramatic improvement in flow rates toward the ports of Houston.
Kodiak is also limited by the fact that it does not own (pdf) any of its drilling equipment. It relies on independent contractors for all of its drilling, which is one factor that could limit Kodiak's future expansion as other players move into the Bakken. Kodiak is able to use independent contractors for its production efficiently now because of its closely spaced leases and its method (pdf) of drilling on pads with two to four wells; this reduces the number of moves between wells that rely on manpower and equipment that are in high demand and short supply. If the demand for these resources were to increase, or if Kodiak were to prematurely expand its operations, it would be challenged to source the bodies and equipment needed, which would negatively impact its production and revenues.
Due to Kodiak's small size and focus on development, it is unlikely that its stock will produce a dividend in the near future. This is excusable considering the company was founded in 2008, but works against the company on the open market as substantially all of Kodiak's competitors are dividend stocks, with an average yield of 1.5%.
Kodiak is currently trading around $9 per share with a forward price to earnings of 7.4 and a price to book of 2.8. By comparison, competitor EOG Resources is trading around $109 with a forward price to earnings of 16.1 and a price to book of 2.3. Occidental is trading around $92 with a forward price to earnings of 9.7 and a price to book of 2.0. Chesapeake is trading around $17 with a forward price to earnings of 6.2 and a price to book of .8. Apache (NYSE:APA) is trading around $96 with a forward price to earnings of 6.9 and an attractive price to book of 1.3.
At first glance it may seem unfair to compare Kodiak to much larger companies like Chesapeake and Apache, but Kodiak's small size and short trading history work against it here. Looking at other operators on the Bakken, Kodiak is dwarfed by any measure except leased acreage, but including market cap and net income, by other publicly traded entities. However, Kodiak is proving that it has the vision and resources to grow its small share in the years to come, whether that is through organic growth or acquisition, so it does look like an attractive buy at current prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.