As promised in my column yesterday, here are updates on the three smaller energy exploration and production (E&P) companies I mentioned. All three would benefit, of course, from higher prices for crude oil and natural gas; I remain bullish on both commodities. Also, as I mentioned in yesterday's column, the SPDR S&P Oil & Gas Explore & Prod. ETF (XOP) has lagged the broader market indices significantly so far this year. I note the individual stock's year-to-date performance in brackets after its symbol.
1. Evolution Petroleum (EPM) (-18.0% ytd). I have extolled the virtues of EPM in several Real Money columns, but the key points remain:
- EPM has no debt;
- EPM's sole asset is a minority position in the long-lived, slow-decline Delhi field (operated by Denbury Resources (DNR) );
- With the completion of a natural gas liquids plant at Delhi, EPM benefits from the marketing of the liquids and very low capital expenditures going forward.
None of these factors is new for EPM, and it is truly the safest play among smaller E&Ps. In fact, the only recent change at Evolution was its Board's decision to raise its already-attractive dividend to $0.07 per quarter. With an extremely safe 3.4% yield, EPM shares offer income investors superior returns. I'm buying EPM for clients at these levels.
2. Gastar Exploration (GST) (-0.7% ytd). Unlike Evolution, Gastar has many moving parts to its story. With a development agreement with a large investment fund signed in the fourth quarter of 2016 and an agreement with Ares Capital in the first quarter of 2017, that provides up to $475 million in corporate capital, so Gastar is well-positioned financially. The so-called STACK play in Oklahoma is one of the hottest areas in U.S. oil drilling now, and Gastar's acreage is in the core of that play.
Gastar's next hurdle is a shareholder vote scheduled for May 2. As part of the Ares transaction, GST needs shareholder approval to grant conversion rights on the $125 million of convertible notes issued by GT to Ares. Without approval, those converts would be transferred into straight high-yield debt with an unfavorable 15% coupon.
So, after flirting with bankruptcy last year, Gastar is one step away from fully regaining its financial footing. Assuming, that is, shareholder approval is granted on May 2. That's a key date in the future of the "new Gastar." I expect the measure to be approved (I'm voting "yes" for my firm's shares) and the removal of the overhang should be a positive catalyst for GST shares.
3. Torchlight Energy (TRCH) (+23.7% ytd). Unlike EPM and GST, TRCH shares have performed very well thus far in 2017. This is a transformational year for Torchlight, as the company looks to drill the first well on its Hazel project in the Midland Basin by mid-year.
At present, Torchlight has virtually no current productive assets -- "PDP" in oil industry parlance -- and proving up Hazel is key to solidifying TRCH's operating future. Management has been looking to raise capital to fund drilling and for other corporate needs, and I believe the capital markets will support such a transaction.
That's the short-term story, but the longer-term cachet -- or Big Gold, if you will -- in the TRCH story is its Orogrande play in Hudspeth County near El Paso, TX. While Orogrande is not currently producing, the two development wells TRCH has drilled there have yielded a wealth of information. In my conversation with TRCH CEO John Brda, he noted that the initial data have done nothing but reinforce his bullishness on the Orogrande, and he singled out the extreme porosity of the rock there as an especially positive characteristic.
So, TRCH has the long-term upside, GST has the near-term catalyst in its upcoming shareholder vote and EPM has the stability of its dividend and debt-free balance sheet. It's a great time to be initiating positions in the smaller E&Ps, and I believe each of the three mentioned stocks will outperform the markets for the balance of 2017.