Looking for Gushers in the Oil Patch

 | Apr 26, 2013 | 2:00 PM EDT
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It has been an interesting week in the market. Investors continue to be deluged with earnings reports from dawn to dusk and the market has gained back a good portion of its steep losses from last week.

Thursday's trading was a bit erratic. The market gave up significant gains late in the day to end trading with decent increases across the indices. One of the trends within the trading day was the huge outperformance in some of the cyclical "risk on" sectors. Mining and materials and the energy sectors all had very good days.

One of the leaders in the market was iron ore producer Cliffs Natural Resources (CLF), which soared 18% Thursday. The trigger was an earnings report after the bell Wednesday that showed a good earnings beat, despite missing on the revenue side -- a core theme to this quarter's earnings results.

Energy shares also rose nicely on a continued rally in oil prices and some better- than-expected results, especially from some of the smaller energy concerns. Thursday, we talked about a possible nascent migration of funds from some of the bid-up defensive sectors like consumer staples into large-cap technology names.

For some of the same reasons (low valuation, higher growth rates, underperforming the overall market so far in 2013) I believe this will occur, bolstering the large-cap technology names, I also think some of these funds will find their way into the energy sector. I particularly like some of the smaller-cap exporation-and-production names in this sector right now.

There are several reasons I like these small producers. They look like they are mostly beating consensus on the top/bottom lines along with solid production guidance. This sub-sector is where most of the growth in production is right now. This should continue as we are in the early innings of the fracking revolution with many of the smaller and mid-cap concerns leading the way. A lot of these smaller names sport very reasonable values given their growth trajectory. Finally, most of the oil majors are struggling to grow production even 2% to 3% a year. This lack of growth has caused many to divest non-core operations (excluding refineries and gas stations) as well as sell less strategic properties to concentrate on growing production from their best assets. Given their prodigious cash flows, access to cheap financing and a solid M&A environment; a logical case can be made that these majors will find adding production capacity via acquisitions could make more strategic sense than finding and developing new reserves.

Here a couple of the smaller names I like.

Matador Resources (MTDR) -- This is a small (enterprise value $700 million) oil-and-gas producer whose primary production comes from the Eagle Ford shale region. Analysts project better than 35% revenue gains for both 2013 and 2014. The company has grown operating cash flow by an approximate 500% over the past two completed fiscal years. MTDR is priced at around 5x operating cash flow and approximately 11x 2014's projected earnings. Several insiders scooped up some 60,000 new shares near the end of 2012 and Canaccord Genuity just initiated the shares as a "Buy" as well.

Synergy Resources (SYRG) -- Another small producer (enterprise value $400 million), SYRG operates primarily out of the Wattenberg field in Colorado. Synergy is growing even faster than Matador, with analysts calling for 80% to 100% annual revenue growth over the next two years. Insiders are also active in purchasing shares, buying almost 350,000 shares in late December/early January. The company has quadrupled operating cash flow since the end of 2011 and SYRG goes for less than 14x 2014's projected earnings. I have owned this stock since it was at $3 a share and the stock is now almost $7. I can easily see the shares going past $10 in the next 12 to 18 months if it continues to meet projections.

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