While Few See It, This Stock Sector Is Getting Risky

While Few See It, This Stock Sector Is Getting RiskyThere continues to be excellent activity in domestic oil and gas stocks, especially in the small- and micro-cap categories. Bakken oil stocks are pushing the valuation envelope even further, as many companies are hitting new highs with stronger production and oil prices.

Recently, in this column, I looked at Triangle Petroleum Corporation (TPLM), which bolted higher on the stock market after reporting exceptional growth in production and in its financials. (See “Why the Street Is So Bullish on This Junior Oil Producer.”)

The stock is very expensive, but the price momentum continues; this illustrates the appetite institutional investors have to bid these companies in a rising spot price environment.

Among large, integrated oil and gas producers, the stock market action is much more subdued because of production issues—declining barrels of oil due to field depletion. Dividend yields are fat, but top- and bottom-line growth is becoming a real issue in the face of declining production numbers. The action for risk-capital traders is definitely in the burgeoning junior producers.


But like all hot stocks in resources, the action revolves almost 100% around the spot price. This is especially the case with precious metals, where even the most exciting growth stories won’t experience a rising share price if spot prices of the underlying commodity are subdued. This is a built-in investment risk with all resource stocks, and it is a disincentive for betting on companies as opposed to the spot price itself.

The price of oil is holding up exceedingly well, considering the tapered geopolitical tensions regarding Syria. Whatever the reasons why prices are nudging $110.00 for West Texas Intermediate (WTI), financial metrics become a lot rosier for junior producers as benchmark prices rise.

Illustrating the kind of growth available from the Bakken region, Kodiak Oil & Gas Corp. (KOG) is producing from the Williston Basin in North Dakota and Montana, as well as the Green River Basin in Wyoming and Colorado.

According to the company, in its second quarter (ended June 30, 2013), oil and gas sales were $173.5 million. This is way up from sales of $85.8 million in the comparable quarter last year.

The company said it sold 2.1 million barrels of oil equivalent (MMBOE) in the second quarter of 2013 for a gain of 103% comparatively. Crude oil revenues accounted for about 94% of total sales.

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) were $131.1 million, compared to $67.7 million last year. Net cash provided by operating activities during the second quarter of 2013 was $118.3 million, for a year-over-year gain of 165%.

But there are no free passes when it comes to genuine economic growth. Kodiak isn’t as pricey as other Bakken oil plays, but it’s still expensive. And institutional investors are all over the position, which means that any earnings misses are going to result in a mass exodus.

Kodiak is now a $3.0-billion company. In July of this year, it was a $2.0-billion company.

For the investment risk, a little exposure to the domestic oil and gas boom is worthwhile. Just remember that everything follows spot prices. Right now, the upward trend for these burgeoning energy companies is intact, but investors still need to keep an eye on the underlying commodity.