Small-Cap E&Ps - Big Presents In Small Packages This Year

by: Bruce Vanderveen


The carnage in energy stocks has driven small-cap E&Ps down to illogical levels.

A careful investor can find hidden gems in the rubble.

Profiled below are five of these “hidden gems” which I feel will rise 50% (or more) in 2015.

After peaking late last summer at around $110 per barrel, oil prices have collapsed - and are now down nearly 50%. As I pen this, prices are approximately $56 for WTI (U.S.) and $61 for Brent (rest of the world). The decline is so rapid and so severe a strong correction may be coming soon - whether prices stay depressed or not. Momentum is still down and we may not have yet seen the bottom.

Why the Oil Price Decline?

The sudden drop in oil since last summer has been a surprise - and a mystery - to most everyone. The magnitude of the fall is especially hard to decipher. Last July almost no one in the industry or financial community saw it coming.

So what's going on? Perhaps the most widely held belief is that Saudi Arabia, with its immense conventional reserves, is producing all out, attempting to cripple competing non-OPEC production. This may be true, but... a 50% decline? In any case, high cost production wells, such as those in shale and deep water areas will likely be in big trouble unless prices reverse soon.

Then there is this: As the Fed withdraws global liquidity by stopping quantitative easing (QE) capital flees risk assets (such as oil and other commodities) and hiding in the perceived safety of short-term treasuries and the U.S. dollar.

Explosive Upsides?

At this point, however, prices for small-cap E&Ps have been driven down so far that just about any good news can spark a huge, if brief, rally.

Consider the following: Before the market opened on December 9 PetroQuest Energy (NYSE:PQ) announced a significant oil discovery and the stock jumped 23% for the day. On December 10 Lonestar Resources (LNREF) updated guidance and saw its shares rocket up 33% the next day. On December 17 Warren Resources (NASDAQ:WRES) shares climbed 28% intraday; the only reason I could find was they rang the NASDAQ opening bell that morning.

Good Managers Know Oil Is Cyclical

Managers are not idiots (we hope). When prices decline they slash capital spending, halt marginal operations, lay off contractors and employees, and more. In other words, they cope and wait it out. And... if they are smart, they will have put protective hedges in place during the good times.

As I noted in an earlier article many small cap E&Ps have great fundamentals and do well - often spectacularly - when oil rises.

Watch Out For Companies With High Debt

The current severe oil price decline has put at risk companies with high debt levels. If they cannot sell their product for enough money to service the debt it's big trouble. Avoid companies with high debt.

With that in mind, here are five small-cap E&Ps which I feel could easily appreciate 50% or more in 2015 if, as I expect, oil prices rise. All five of these companies have relatively low debt (or none) and most have protective hedges. They should not only survive but thrive once oil recovers.

Abraxas Petroleum (NASDAQ:AXAS) operates in the U.S. Rocky Mountains, South Texas, Powder River Basin and Permian Basin. Abraxas is 49% off its 52-week high of early July. Debt is low and insiders have bought almost 300,000 shares over the last three months while no shares have been sold over the last 12 months. A recent Seeking Alpha article claims Abraxas has a breakeven cash flow at $47 WTI.

Callon Petroleum Company (NYSE:CPE) is focused on its Permian operations in Texas. Callon is down 53% from its 52-week high early last July. Debt is low and insiders have bought almost 19,000 shares over the last three months while selling none. In 2013 Callon shifted its focus from the Gulf of Mexico to the Permian. Roth Capital just initiated coverage on Callon with a buy rating and a price target of $13.50.

DeeThree Exploration Ltd. (DTHRF) produces oil in west-central and southeastern Alberta. DeeThree is down 59% from its 52-week high of late last July. Debt is moderate and insiders were heavy buyers in mid-to-late October and early December. DeeThree has managed to grow production and reserves quickly over the last four years while keeping costs and debt under control.

Matador Resources (NYSE:MTDR) operates in the Eagle Ford and Permian. Matador is down 33% from its 52-week high late June. Debt is low and in the last 12 months there have been 71 insider buys and 3 sales. Matador just indicated it may temporarily suspend its Eagle Ford operations because of low prices.

TAG Oil Ltd. (OTCQX:TAOIF) operates in the Taranaki, East Coast, and Canterbury basins of New Zealand. Tag is down 59% from its 52-week high of early January. Tag has no debt and is repurchasing shares. The company has seen insider acquisitions since August. Tag was recently disappointed when it had to abandon for safety reasons its Waitangi Valley exploration well in the petroleum rich East Coast region.

Company Stock Price Market Cap Total Debt Prime Operating Area
Abraxas Petroleum $3.26 $340m $61m U.S. Rockies, Permian, Gulf coast
Callon Petroleum $5.69 $415M $103M U.S. oil Permian
DeeThree Exploration $4.67 $321M $94M Canada (Alberta) oil
Matador Resources $19.02 $1.4B $250M U.S. Oil Eagle Ford and Permian
TAG Oil $1.36 $86M No debt New Zealand

Data as of 12/20/2014, sourced from Yahoo Finance and company websites

At this point prices may be near their lows. All the above companies were up big in the relief rally of last Friday, December 19 and well above their 52-week lows. Will it continue? Maybe, maybe not. It all depends on the price of oil.

It's important in the speculative small-cap arena so allot only the portion of your investments you feel comfortable taking risk with.

Also, use the shotgun approach. Make small investments in several companies and use stops. This provides protection if one or two go bad. It may take patience but I feel by next year most, if not all, of the above profiled stocks will be significantly higher. Expect a wild ride though.

Disclaimer: This article is the author's opinion and a quick pick list. Investors who are considering investing in the above companies are strongly advised to do further research and consult a financial advisor before investing. Several Seeking Alpha authors have written on these companies in greater depth.

Disclosure: The author is long AXAS, CPE, DTHRF, MTDR, TAOIF, WRES.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Small positions in all the above.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.