The US oil exploration and production (E&P) sector is going through a historical period. The shale oil and gas revolution has revitalized a sector that is more prone than ever to go through a consolidation process. Taking this into account, I should also note that great small-capitalization companies with key assets are always merger and acquisition (M&A) targets. For this reason, I have chosen three US E&P companies that fill all the required M&A criteria. Let’s take a look at them.
This company keeps on drilling rich areas
Rex Energy Corporation (NASDAQ:REXX) is an independent oil and gas company whose main operations are in the Appalachian Basin and Illinois Basin. For the first quarter, this $900-million market capitalization company reported EPS of $0.10, in line with consensus estimates. It also provided updated production guidance for the second quarter.
As expected, 1Q13 production averaged 75.6 million net cubic feet per day of natural gas equivalent production (mmcfed), 18% being liquids, exceeding the upper-end of management’s guidance.
Over the past year, Rex Energy Corporation (NASDAQ:REXX)’s operating focus has shifted toward the Appalachian Basin, and specifically the Utica Shale. This should be a transforming year for the company, driven by extensive drilling. Besides, Rex Energy Corporation (NASDAQ:REXX)’s equity-raise and completed asset sales in 2012 provide the company with sufficient liquidity for its drilling plans through 2014.
Rex keeps on acquiring key acreage in areas such as the super rich Marcellus Shale, and is going forward with its profitable investment plan. Trading at 2013 and 2014 price-to-earnings (P/E) ratios of 26x and 16x, respectively, Rex Energy Corporation (NASDAQ:REXX) is a great bet on one of the most dynamic sectors in the U.S., and one that is the most prone to M&A in the next few years.
A company with a high oil growth outlook
Carrizo Oil & Gas, Inc. (NASDAQ:CRZO) is a $1.1 billion independent oil and gas company focused on exploration, development and production of shale oil and gas. Its primary activity is in the Eagle Ford, Marcellus, Niobrara and Utica Shale plays. At the end of 2012, the company had proved reserves of 115.1 million barrels of oil equivalent (MMboe); 61% of that was natural gas, and 39% was liquids.
I think Carrizo Oil & Gas, Inc. (NASDAQ:CRZO) is an attractive investment within the small capitalization E&P segment for two reasons: the company’s above peer-average oil growth profile, which should be around 30% in 2013; and Carrizo Oil & Gas, Inc. (NASDAQ:CRZO)’s relatively low valuation.
Carrizo Oil & Gas, Inc. (NASDAQ:CRZO)’s production growth should come primarily from a ramp-up in crude oil and condensate volumes from Eagle Ford, with additional growth in the Niobrara, Marcellus and, in 2014, Utica fields. The oil/gas mix will increase from 40% in 2013 to nearly 50% in 2014. Higher liquid volumes will boost 2013’s operating cash flow.
This, alongside an increased borrowing base, should help ease any capital funding concerns that investors may have. As a matter of fact, the company’s liquidity position is comfortable at above $600 million. Moreover, the company’s recent acquisition of 4,300 net bolt-on acres in the Eagle Ford strengthens the long-term, high-oil-growth outlook.
Trading at 2013 and 2014 P/E’s of 13x and 10.8x, respectively, Carrizo Oil & Gas, Inc. (NASDAQ:CRZO) is the cheapest US play among the small capitalization E&P companies that I could find.
Huge acreage soon to be exploited
Approach Resources Inc. (NASDAQ:AREX) is a $1 billion market capitalization independent E&P company that is looking to develop unconventional oil and gas assets. Approach Resources Inc. (NASDAQ:AREX)’s primary operating area is in West Texas in the Permian Basin. The one interesting feature of Approach is the company’s core concentrated position in the Permian Basin.
Approach Resources Inc. (NASDAQ:AREX) was one of the first companies to drill into the rich Permian Basin, which has become a focal point for the industry since early 2012 given its high oil content. Approach Resources Inc. (NASDAQ:AREX) accumulated 145,000 net acres in the basin that are essentially contiguous. It’s basically a start-up company, but the possibilities are enormous.
Trading at 2013 and 2014 P/E of 68x and 32x, respectively, Approach Resources Inc. (NASDAQ:AREX) is a bet on the successful development of the Permian Basin. Besides, founding should not be a concern. I expect the company to issue $300 million in debt in order to pay down the outstanding $152 million under its credit facility and fully fund the drilling program of the next two years. This would bring the company’s net debt/capital to a very comfortable 32% versus the peer’s average of 40%.
The shale oil/gas revolution is here and many small capitalization companies such as the three named above are playing a key role. I expect huge M&A activity in the sector in the coming years as many of this small companies own a big portion of the most valuable territories for shale development.
The article Three Small-Cap Oil Companies for Your Watch List originally appeared on Fool.com and is written by Federico Zaldua.
Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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