According to its first quarter 2012 earnings report, Kodiak Oil & Gas (KOG) brought in just under $80 million in total revenues in the first quarter, compared to $13.3 million in the first quarter of 2011. Oil made up 96% of revenues in the first quarter of 2012, or $77 million, which is reassuring given the current natural gas price environment.
Following its earnings report, Kodiak released an interim corporate update providing details for its drilling activities in the Williston Basin in North Dakota on the Middle Bakken and Three Forks formations, where most of the company's acreage is held. A completed well on the Three Forks formation is producing an average of 1,454 boe per day and a completed well on the Middle Bakken is producing an average of 2,033 boe per day. In the same release, Kodiak indicated that two more wells on the Middle Bakken will be placed into production in the very near future.
Control in the Williston driving profits
Kodiak has 74% or greater net revenue interest in all of the above mentioned wells, and as Kodiak noted in the interim corporate update, these are the first wells Kodiak completed on the acreage it acquired in the Williston Basin between June 2011 and January 2012. Kodiak expects the Williston Basin to have takeaway capacity over 1,400 mbbl per day by the close of 2013, increasing to nearly 1,800 mbbl per day by the close of 2014. If its estimates are realized and its high revenue interest in its producing wells is maintained, I believe Kodiak could double its revenue by the end of 2013, provided that its operating and credit costs remain stable.
Kodiak has $550 million set aside in its 2012 capital expenditures budget for drilling and completion. This is an aggressive drilling schedule for Kodiak, considering that its total capex budget for the year is $585 million. However, given that the company completed acquisitions over the last year that doubled its total acreage, I think it makes sense for Kodiak to pull back and focus on exploiting the resources it now has. As evidenced by the production rates in North Dakota above, the recent acquisitions are valuable to Kodiak and relatively easy to drill. Kodiak is estimating that at a WTI Cushing Crude Oil Spot Price of $95 per bbl, long lateral well payouts on the Bakken will occur within 25 months. At $75 per bbl, payout is estimated to occur within 38 months.
Potential for increased operating costs
Kodiak is drilling on Williston with a 24-hour frac crew provided by a third party company. In its first quarter earnings report, Kodiak indicated that it intends to hire out a second completion crew to accelerate its development. It is unclear whether this second crew would be provided by the same company, with which Kodiak has an early termination agreement that would entitle the third party to a $36 million payment should Kodiak cancel the contract early.
Kodiak has an added incentive to focus on drilling, despite the necessity of hiring out for the majority of its manpower needs, since it must retain rights to its newest acquisitions through activity. With its current schedule, Kodiak estimates that its holdings in Dunn County North Dakota and McKenzie County North Dakota will be held by production by the end of this year, and its acreage in Williams County North Dakota will be held by production by the end of 2013.
Kodiak's properties in the Williston Basin are constrained by the lack of available infrastructure, as well as by manpower limits. As noted in its first quarter earnings report, Kodiak's wells in McKenzie and Williams counties are substantially serviced by gas pipelines, but oil pipelines capable of servicing production are still under construction. However, Kodiak is optimistic that most of its wells here can be connected to oil pipeline by the end of 2012. Kodiak is also working on constructing of the water disposal wells necessary to its fracking activities, with one out of the planned three disposal wells completed as of March 31. The lack of this infrastructure raises Kodiak's operating costs, which in turn decreases revenue.
EOG Resources (EOG), Marathon Oil (MRO), ConocoPhillips (COP) and Exxon Mobil (XOM) are also active in North Dakota, with a similar focus to Kodiak on the Williston Basin. EOG in particular is seeing exit rates similar to Kodiak on its acreage here, with ranges from around 900 to 3,415 boe per day. EOG, however, has a larger spread in its working interest rates on these wells, from as low as 51% in Mountrail County to as high as 100% in McKenzie County. Fortunately for EOG, its greatest exploration successes are trending towards McKenzie County where its potential revenues are higher. Still, Kodiak is in a better position on these properties due to the greater directional control and higher revenue potential granted by its larger working and revenue interests on its drills.
Kodiak is currently trading around $9 per share, up about $0.50 or 6% since its first quarter earnings report was released on May 3. This gives Kodiak a price to book of 2.6, which is substantially higher than the current industry average of 1.7. It should be noted that the industry average does group small growth stocks like Kodiak in with the super majors, and there is a gap between the value ratios for mostly-domestic, unconventional energy companies like Kodiak and those for the established international firms. For example, EOG Resources, which is largely domestic and unconventional like Kodiak, has a price to book of 2.1 on a share price around $101.
Supermajor and large value Marathon on the other hand has a price to book of 1.0 on a share price of $25. ConocoPhillips is similar, currently trading around $53 with a price to book of 1.0, which shows investors are putting more faith in Kodiak and EOG's growth potentials than in the growth potential of Marathon and its ilk. Exxon Mobil, which is exhibiting more flexibility in exploring unconventional drilling and exploration opportunities, is currently trading around $82, giving it a price to book similar to that of its much smaller unconventional peers, at 2.5.
Kodiak continues to grow, and its acquisition spree in the Williston Basin gives it the acreage it needs to increase production and revenues even further in the coming quarters. As it grows, I expect that it will be able to build its own production teams and infrastructure, freeing it from dependence on third parties and potentially onerous contract obligations. At $9 per share Kodiak is undervalued against its potential, and should be strongly considered as a buy.