A Compelling Energy Story

 | Sep 11, 2013 | 10:00 AM EDT
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Carrizo (CRZO), a mid-cap oil and gas producer and major player in the premier shale regions, including Eagle Ford and Utica, has recently announced a plan to sell the remainder of its long-held Barnett Shale acreage for $268 million. This is the final move in an incremental process to sell off the company's once huge position in North Texas, and also part of the company's greater plan to shift focus from natural gas to oil. 

Carrizo got its start at unconventional shale drilling in North Texas, acquiring land there over a decade ago. By selling its remaining 9,000 acres, Carrizo has now satisfied its funding gap and can continue spending capital on newer, higher-return, liquids-rich plays. This was a good move.

On March 26, I recommended Carrizo on its remarkable oil production growth. The stock has since jumped 24%. I believe this company will continue to do well as it develops the Eagle Ford site and now begins drilling in the nascent Utica shale.

Why Carrizo Sold

Previously a shale gas producer, Carrizo finally caved in to reality in 2010. Realizing that natural gas was in a structural glut that would not be solved anytime soon (it still hasn't), CEO Chip Johnson turned the company's rudder to alter its course toward shale oil. At that time a juggernaut in the Marcellus and Barnett, the two best gas shale areas in the country, Carrizo began acquiring positions in the Niobrara and the Eagle Ford. To fund this, management incrementally sold pieces of its Barnett shale over three years. Late last year, Carrizo sold all of its North Sea assets for the same reason.

Meanwhile, the company's oil production grew rapidly in the Eagle Ford area, which soon became the center point of the business. Later, yet more discoveries were made in the Utica shale area in eastern Ohio and Carrizo decided to jump in as an early entrant. Carrizo now has 15,500 acres in Utica.

Developing acreage in Eagle Ford, a "green field" shale, was and is a capital-intensive task. Most of the company's recent capital expenditures have been spent on the Eagle Ford operation. But with the company plunging into the Utica, Carrizo's need for land and development capital is overwhelming. Carrizo has had to sell off its Barnett, UK and some Marcellus assets to build up a new base.

Turning the Corner

Proceeds of this deal are going toward two things: Reducing debt amassed by previous acquisitions, and satisfying the company's 2013 funding gap. This asset sale does both. Next year, Carrizo finally expects to be "cash flow neutral." This means Carrizo's operating cash flow will equal its capital expenditures for the first time in several years. All on the back of increasing oil production with a high rate of return.

Carrizo's recent asset sale is to be commended. It has done a good job repositioning itself as an oil company, and Johnson's strategy will soon begin paying off in a big way. Carrizo is still a buy right now. The stock's book value is a fair 2x, which is better than some of its other fast-growing mid-cap peers, including Gulfport (GPOR) (3x), Rosetta (ROSE) (2.37x) and Goodrich (GDP) (8.1x). The company's narrowing focus on oil and its fantastic production growth make it a compelling story.

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