A Pair of Energy Plays

 | Jul 18, 2013 | 11:00 AM EDT  | Comments
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Stock quotes in this article:

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,

mpo

The energy sector, with the exception of the refiners, has performed well in July after underperforming the overall market in the first half of the year. I believe this strong performance will continue for the rest of the year and I am overweight the sector. Oil prices remain above $100 per barrel, valuations are reasonable and the sector is delivering one thing that the overall market seems hard pressed to: robust growth in earnings and revenues. I particularly like some of the fast-growing small-cap Exploration & Production names that are core drivers of the continuing domestic energy production expansion in the U.S. Here are two plays I have not covered previously on Real Money.

Diamondback Energy (FANG) is a small, independent E&P concern whose production comes solely from its acreage (over 50,000 net acres) in Texas's Permian Basin. Aside from having one of most memorable ticker symbols in the market, the stock has more than doubled since going public in October 2012. The company is experiencing robust production growth, ending 2012 producing some 4,300 barrels of oil equivalent/day, and is already running at more than 6,000 BOE/D currently. It has guided toward 7,200 to 7,500 BOE/D by the end of this year.

Two-thirds of Diamondback's production is oil. In addition, the Permian Basin has one of lowest breakeven points of the major energy basins in the U.S., which should mitigate any decline in oil prices, along with risk management programs that hedge 40% to 70% of production. The company has grown proven reserves at better than a 50% annual rate over the past five years and production growth has averaged better than 60%. The company has a solid balance sheet and FANG sells for about 16x 2014's projected earnings, which is more than reasonable given its production growth trajectory.

Midstates Petroleum (MPO) is the mirror image of Diamondback as far as stock performance goes. The shares have dropped some 40% over the last year but the stock appears as if it has bottomed recently at just below $6 a share. Midstates has oil and gas properties in the Mississippi Lime, Anadarko and Upper Gulf Coast shale regions. The company recently made a major acquisition that will more than double revenues in 2013, and analysts expect almost 50% sales growth in 2014.

The company posted a small profit of $0.09 a share in 2012, but it is on track to post approximately $0.25 per share this fiscal year. Current consensus earnings estimates for 2014 hover above $0.40 per share. CEO John Crum has more than 1.2 million shares and he has been adding to his stake at these levels. The company does have a substantial debt load but the majority of its debt maturities are far in the future, it has ample liquidity, and the company has 80% of 2013 production hedged. Provided the company can deliver on the growth projections analysts have for it, the stock should recapture previous highs in the medium term.

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