Kodiak Oil & Gas (KOG) put in a strong second quarter, with earnings per share of $0.10 in line with analyst expectations and a slight improvement over the first quarter of this year, when Kodiak reported earnings per share of $0.09, slightly below analyst expectations, again at $0.10. Kodiak's revenues are tracking upward steadily, but its total proved reserves are increasing by leaps as the company drills its inventory and is able to report major successes on its leaseholds.
The trend in its proved reserves also owes much to Kodiak's acquisitions strategy, which contributed to 40% gains in total acreage in each of the last two years. These acquisitions came at a good time, well before recent spikes in lease prices, and will allow Kodiak room for strong growth on its current position.
Still a Major Player, Despite a Pile On
With daily sales volumes of 12,700 boe per day Kodiak is not a powerhouse compared to other operators in the Williston Basin, but it is a major player by proved reserves and total acreage. As of the end of the second quarter, Kodiak was working with 155,000 acres in the Williston representing 70.1 mmboe in proved reserves, with an 86% weight towards liquids. Compare this to Northern Oil & Gas (NOG), which is producing 10,400 boe per day from its 180,000 acres in the Williston but could claim just 46.8 mmboe in proved reserves. This indicates that Kodiak is taking a more considered approach to drilling to coax more resources out of fewer acres, and began with a stronger acreage position than Northern.
Both Northern and Kodiak must contend with Continental Resources (CLR), which is the number one oil producer in the Williston Basin on nearly 1 million net acres. By any measure Continental is larger than pure plays Northern and Kodiak, and I think that Continental's land grab may be a strategy to edge out competitors on its level, which could be devastating for smaller players. Recent leases in oil heavy McKenzie County, North Dakota are pricing as high as $10,500 per acre for partial acres, meaning Kodiak may have to sit out bidding on the best parcels and focus on drilling the acreage it has.
By focusing on only one play, Kodiak management and operations are able to focus on cost and growth consistently. One way Kodiak is attempting to bring down well costs is through using alternative sand mixes in fracking operations. It recently completed a Three Forks well on its Wildrose Prospect, Holland 9-19H, using white sand tailed with resin coated sand. According to Kodiak Chairman, CEO, and President Lynn Alan Peterson, this mix brought the cost of the well down by $2.5 million, and the well still provided an initial production rate of 225 boe per day. The Holland well was drilled by the previous leaseholder and only completed by Kodiak, which could be a factor in the lower than usual IP rate. However, Kodiak is drilling three wells nearby and has several nearby permitted locations that might return better results and prove out the currently prospective Wildrose. Peterson believes that the cost per well in this area could realistically average $7.5 million, significantly below the $9.2 million that Continental estimates wells in this area will cost for its operations.
This is also helping Kodiak to avoid one of the major negative aspects of some of its competitors. Both Chesapeake Energy (CHK) and SandRidge Energy (SD) are examples of exploration and production companies that started small but did not stay small for long thanks to exponential growth, but that growth came at a price.
Chesapeake became less of an E&P and more of a finance company by pursuing aggressive growth through trusts like the Chesapeake Granite Wash Trust (CHKR) and a strategy of buying assets at rock bottom prices then selling these in enormous monetizations, as it did with its $1.15 billion volumetric production payment with Barclays Bank in 2010. This strategy worked fine for Chesapeake while oil and gas prices, and the company, were strong, but by dividing its focus Chesapeake missed the warning signs on gas prices and was unable to pivot towards oil in a meaningful and timely way.
Now Chesapeake is struggling under drastically decreased revenues after prematurely exhausting most of the drilling carries it received from its joint venture partners, and is unable to unload the leasehold it now needs to sell to stay solvent. What's making the situation even tougher for Chesapeake is its overly complex balance sheet, which is complicated by its spin off trusts and subsidiaries. In addition to its other problems, I think this unneeded complexity is a factor in its low stock price, since investors don't want to invest in an E&P that looks more like an asset broker.
SandRidge was heading in the same direction as Chesapeake, although since earlier this year when Chesapeake came under fire for its complicated structure and natural gas prices collapsed, SandRidge is cooling off on repackaging and selling off assets under royalty trusts. Its last spinoff, SandRidge Mississippian Trust II (SDR), made its IPO in April 2012 with an expected price between $19 and $21. Recent trades are at the midpoint of that range, around $20, which is almost lucky for SandRidge given the current price environment.
Kodiak is currently trading around $9, with a price to book of 2.4 and a forward price to earnings of 9.1, as compared to its closest competitor, Northern, which is trading around $18 with a price to book of 2.0 and a forward price to earnings of 14.1. For reference, SandRidge is trading around $7, with a price to book of 1.2 and a forward price to earnings of 15.2. Chesapeake is trading around $19 with a price to book of 0.9 and a forward price to earnings of 10.0, showing that the stock is sliding along with Chesapeake's revenues.
On the healthy side of the balance sheet, Continental is trading around $74 with a price to book of 4.8 and a forward price to earnings of 16.0. While Continental is a strong company and investors are rewarding it for another quarter of strong earnings, I believe this reflects an overvaluation on Continental given its segmented strategy and consistent but relatively low growth rate.
Kodiak's early entry on the Williston allowed it to begin accumulating significant acreage at reasonable prices, but as more players pour into this basin I think Kodiak's chances for significant growth on the play outside its current acreage are slim. Fortunately, Kodiak has an expansive drilling inventory with its leasehold, and can fuel near term growth from what it already has. Along with this, I think that once Kodiak really starts the ball rolling on its drilling schedule, an expansion outside of the Williston is more than possible. At current prices Kodiak is a great buy.