If you’ve bought Kodiak’s (KOG) stock in 2012, there’s no doubt you’ve paid a premium. Outside of a few earlier stage companies, there’s not many independent U.S. E&P companies that trade on multiples as high as Kodiak. This doesn’t necessarily mean you overpaid or that the company is overvalued, because with reserve and production growth of more than 500% and 400%, respectively, it has been growing faster than Barry Bonds’ nose during the past year (year and half for reserves).
Just how highly valued is Kodiak?
Well, the company is trading at an enterprise value to trailing-twelve months production (EV/TTM Production) of $1,027 per BOE ($374,773 per flowing barrel) and EV to reserves of $46.05 per proven reserve. These multiples represent a 105% and 33% premium, respectively, to the peer averages in the chart below.
For KOG to receive a valuation on its production equivalent to that of the peer group below, it would need to produce at a TTM Production rate of 6,452 thousand barrels of oil equivalent (MBOE) or 17.7 MBOEPD, which is 105% more than the company’s TTM production at June 30, 2012. While this number is significantly more than the company’s TTM number, it’s not much more than the company’s current production rate. In its second quarter (Q2’12) conference call, KOG revealed that it produced at a rate of 17,000 BOEPD during July and if the company keeps this rate flat for the next year its TTM production will be 6,205 BOEPD, nearly the same rate as the peer group multiple implies. Furthermore, the company expects to exit 2012 producing at a rate of 27,000 BOEPD, so one could easily argue that KOG’s current production will outgrow the peer group production multiple below within the next year.
Kodiak Peer Multiples
The peer group reserve multiple above of $34.59 per BOE implies that the market expects KOG’s reserves to be valued 33% higher than the peer group, meaning the market believes KOG is turning unproven reserves to proven reserves at a relatively higher rate. There’s plenty of reason to agree with the market’s assessment, as KOG has grown reserves more than 500% during the past two years and more than 36% so far this year. While growth as a percentage may slow down moving forward, the fact is the company has only completed 82 of its 807 net potential well locations in the Bakken, meaning it has plenty of acreage to prove up and grow reserves.
Of these 807 potential locations, 564 of them lie in the company’s Dunn County, Koala, Smokey and Polar prospects where its completions have been strong. Where the company may run into trouble with its margins in the Bakken are with its Grizzly and Wildrose prospects, which comprise 244 or 30% of its net locations. The Grizzly prospect wells have been smaller to date and the company attributes this to lower pressure in the Western portion of the North Dakota Bakken. Its most recent completions in the prospect have had 30-day IP rates of 328, 248 and 394 BOEPD which is approximately 1/3 of the rates it has achieved in its Koala prospect. KOG does anticipate these wells having shallower declines, but it remains to be seen how economic they will be.
The company has shelved drilling in its Wildrose prospect (this acreage is HBP) for the balance of 2012 after completing two wells there. It does expect to earn 20% IRRs across this acreage, but believes the economics there are not as strong as in its other acreage. While this bodes well for economics in its other acreage, the Wildrose wells came in below expectations (one came in at 225 BOEPD) and this combined with the company’s plans to shelve the acreage for now doesn’t speak highly of it.
Financially, Kodiak is in decent shape with respect to its peers. Average LOE and G&A costs per BOE without HK (HK was included in this analysis for its valuation multiples) total $14.03 and $7.58, respectively, meaning KOG could improve its valuation by operating more efficiently. The company should pare down expenses as it matures as an operator and increases scalability. CLR does bring down the costs in this analysis, but note it’s a more mature company that is very well run. I’m comfortable with KOG’s current debt level; however it’s getting close to debt levels that the market could deem excessive at its current size. The company’s interest coverage ratio is low, particularly with respect to its Bakken peers (CLR and OAS). While it only recorded interest expense of $8.2 million during the six-months ended June 30, 2011, it actually paid an additional $25.0 million in interest expense, but this amount was capitalized.
KOG was been a serial issuer of equity capital during the past few years and has begun to issue debt as of late. While the company has succeeded in putting this capital to work, its financial condition will be in a lot better shape once it grows production to the point where it can spend within cash flows. Operating cash flows for the first six-months were only $90 million and while this figure will improve substantially during the balance of the year, the company will have spent an estimated $650 million on capital expenditures by the end of 2012 and I doubt it slows down spending anytime soon. I’m not raising the red flag on KOG, but there’s certainly a chance it goes to market to fund its 2013 capital expenditures and its debt levels (while manageable at this point) deserve monitoring moving forward, particularly if oil prices take a dive.
There’s a lot of reasons to like Kodiak. It has a strong asset base with more than 100k premium Bakken acres giving it plenty of room for future growth. In addition, these guys are great operators who run an efficient company which will only become more efficient as it grows. Where it runs into trouble is that it’s trying to grow faster than its balance sheet can handle and its liquidity issues will start to compound if it continues to sell debt. KOG is constantly mentioned in acquisition talks these days, and for good reason as I believe it needs someone to take it to the next level. To that point, it’s worth noting that Brigham was bought by Statoil (STO) in 2011 at a 36% premium while GeoResources (who did own some Eagle Ford) was bought by Halcon (HK) last spring at a 24% premium (I’d expect something closer to Brigham’s premium for KOG). If management chooses not to sell, investors should be prepared to be diluted again sometime within the next six-months. I would buy this stock at its current valuations, but I wouldn’t pay much more.