Placing a value on an exploration and production (E&P) energy company can be difficult. Is the company worth "X" for the oil it is currently pumping, or is it worth "Y" for the oil it owns that is still in the ground? The answer is, of course, "yes". When valuing these companies you have to factor in both current production and future potential. We're going to examine the numbers for three E&P companies to see how the market places a value on them. (To learn what to look for in an energy company, see Oil And Gas Industry Primer.)
Rescuing Stranded Gas
Quicksilver Resources (NYSE:KWK), with a market capitalization of just over $3 billion and sales of $450 million, has a simple but unique strategy: find gas where it isn't supposed to be and buy it cheap. Over the last five years KWK has bought acreage in unconventional places in Texas and Canada where gas was not supposed to be and - viola! Gas! This strategy has worked well for the firm, as although this stranded gas is slower to come out of these unconventional places it tends to last for longer period of time.
How well has it worked? For the last three years revenue has expanded at a 40% pace while earnings have grown at about 61%. Quicksilver realizes a 21% net margin from a gross margin of 75% and returns a respectable 15% on equity.
Investors should know that Quicksilver Resources is highly leveraged and has to secure financing to exploit opportunities. Although management has a significant stake in the stock of Quicksilver, the Darden family still owns 34% of the company and has three seats on the board. Investors have to trust that their best interests are aligned with those of the management and Darden family.
Acquire Now, Exploit Later
Whiting Petroleum (NYSE:WLL), with a market capitalization of $1.5 billion and sales of $747 million, has only been a public company since late 2003 when they were spun off from Alliant Energy (NYSE:LNT). Whiting has done a remarkable job of building its reserves. Through a series of seven acquisitions in 2004 and 2005 WLL increased its reserves by more then 250%. The company's recent Celero acquisition has made Whiting as much of an oil company as a gas one.
With only a brief history behind it, Whiting has established some impressive numbers. Over the last three years the company's revenue has grown at a 67% rate while its earnings have grown at just over 63% from the same period as well. Although the company's return on equity is only 9.4% you have to keep in mind the company's focus has been on building its portfolio of reserves and not on production. However, over the past three years, the shares have managed to climb about 75%.
Indeed, that is Whiting's stated strategy - acquiring reserves now and exploiting them later. Hedging up to 60% of its assets, WLL wants to build its portfolio to 1 million to 3 million cubic feet of gas. At the end of last year the company had proven reserves of roughly 1.5 million cubic feet, so we have to assume that the goal is more toward the higher end. Once this goal is established, the Whiting should be exploiting the reserves it has acquired.
Plenty of Leverage
Ask any futures trader - leverage works both ways. Delta Petroleum (Nasdaq:DPTR) is finding out the hard way after some recently disappointing results. Similar to Whiting, Delta has been busy building reserves and planning for futures production. However, unlike Whiting, Delta Petroleum's numbers are rather dismal. Its earnings have gone nowhere despite its revenue for the last three years growing at a 76.7% rate. A gross margin of 16.7% produced a net margin of a -69% and it all boils down to a -24% return on equity. The market has shown some faith, or perhaps just a pure asset play by appreciating the shares about 40%. In either case, Delta's debt-to-total-capital ratio is about 45%. That's a lot of leverage.
At some point Delta is going to have to start producing something from the assets and partnerships it has managed to acquire. Bottom line, Delta has only developed 3% of its 1.42 million acres.
'Leap-of-Faith' Index
Stock performance aside, just how much faith does the market have in these companies? Quicksilver Resources trades at a price-earnings (P/E) multiple of 34-times and a market-capitalization-to-revenue ratio of 7.3-times. In Whiting Petroleum's case that P/E is 13-times and market cap to sales is 2.0. Lastly, for Delta Petroleum there is no P/E since there are no earnings; however, sales to market capitalization is 5.8-times. To what extent you want to prime the pump is entirely up to you.
