Look at the cash flow carefully. A number of small and microcap E&P companies show very bad earnings due to write-downs, lower commodity prices, etc. However, many of these managed to have positive cash flow from operations even during the lowest commodity pricing, due to depletion, etc.
The other thing to look at carefully is the lending. This is the trap that most of these companies seem to have fallen into. Even though they make their payments and have positive cash flow, their producing properties are collateral for loans, and when the asset value drops due to low commodity pricing, loan covenants are triggered and debt must be restructured or the companies are in default. The companies may be required to suddenly pay back a lot of principal they simply don't have and aren't likely to get. For this reason, I prefer to wait for restructuring to take place, then evaluate whether the company will likely survive.
MEXP appears to be a definite survivor, based upon essentially a loan from the Miller family. The company needs around $6 million to pay back principal; the Miller family will buy and hold some assets for $6 million, and make these assets available for repurchase in December. Vertias will accept warrants in lieu of interest on some 3-D seismic expenses MEXP owes.
Obviously, Vertias believes MEXP will survive, and has some excellent exploration prospects. Also, the Miller family owns around half of MEXP, and only went public to grow the company. They didn't sell their holdings during the IPO, and they have, along with many directors and officers, been adding to their holdings.
AXAS apparently never triggered loan covenants, and I base my confidence in their financing on positive cash flow in the worst commodity pricing environment, and the recent debt placement. Neither company seems in danger of delisting, as their prices are above $1 and appear to be past bottoms.
Also, both of these companies have experienced considerable insider buying in recent months, at prices quite a bit higher than today's. Insiders are usually attuned to the inside "poop" and would hardly commit more personal funds if the bank was about to lower the boom and the company likely wouldn't survive.
I am a little less certain about SMIN, based upon negative cash flow last year. I have an existing position, which I have not increased this year. However, they successfully restructured their debt recently, and with higher commodity pricing and some asset sales it seems likely that they can pay the principal tranches due in September, or possibly restructure again with a higher line of credit based upon higher asset values.
SMIN also is actively shopping the company, and was granted an appeal in late May from delisting from NASDAQ. Also, the CFO told me that their board can do a reverse split to stave off delisting without shareholder approval, since they are a Nevada corporation. I would say SMIN is definitely the riskiest of the microcap E&P companies I have a position in. Still, I'm not bailing out.
Another holding is PETD, which definitely will survive and do very well. The stock sells at $3-3/4, less than book, has had positive earnings throughout this period, is 100% natural gas, and has $2.25/share in cash and no long term debt. PETD has been stepping up it's drilling program for natural gas, now taking on some higher risk but higher potential reward drilling in Colorado and Montana.
I also hold SFY, which is more of a small cap, and a definite survivor. SFY has managed to turn a profit through the low commodity prices, and use the cyclical bottom to shift from drilling to acquisitions. Now, SFY will likely shift back to drilling.
Another small cap I hold is XTO, which has managed to improve cash flow over last year, although understandably earnings are off. XTO will survive and likely double over the next year.
I also hold EVER, another small cap, which has continued to grow earnings and production. EVER has the lowest natural gas lifting price of any production company, and seems able to make a profit at almost any likely natural gas pricing. However, EVER is selling at quite a P/E and cash flow premium. I sold part of my EVER holdings, which I bought at $4-1/8, for $22 in order to finance increased holdings in AXAS and establish a position in MEXP. |
