RealMoney Silver - Growing WTI Could Be a Real Find

Growing WTI Could Be a Real Find
By Bill Trent
RealMoney.com Contributor
5/7/2008 2:33 PM EDT

I think there is still quite a bit of run left in the energy bull market. That belief has led me to some good picks, such as Patterson Uti (PTEN) and Flowserve (FLS) , as well as one bad one, Frontier Oil (FTO) . My models recently brought W&T Offshore (WTI) into focus, and I'm thinking it is more likely one of the former than the latter.

W&T is an independent oil and natural gas producer, active in the acquisition, exploitation, exploration and development of oil and natural gas properties in the Gulf of Mexico. It has begun extending its traditional expertise in the conventional shelf (less than 500 feet deep) to exploring deepwater and deep-shelf sites up to 15,000 feet deep. Since becoming a public company in 2005, its revenues have more than doubled, driven by rising prices and increased sales volume.

The company has recently enjoyed a successful exploration streak. In 2007, it drilled seven exploratory wells and two development wells. Both of the development wells were successful, as were six of the exploratory wells. Since that time, the company has announced that it is 6-for-6 so far this year. It is also growing through acquisitions of small projects from larger oil producers that want to focus on more capital-intensive projects.

The growth will ultimately be needed. By management's own estimate, the discounted future cash flows from its proven reserves amount to just $2.1 billion, well below the current market capitalization. To that end, the company is dramatically expanding its exploration activities. During 2008, it plans to drill 44 exploratory wells and six development wells and projects capital expenditures of about $800 million, $450 million of which is expected to be spent for development activities, $330 million for exploration and $20 million for seismic.

In 2007, the company generated $329 million of free cash flow, sufficient for a hefty 10.4% free-cash-flow yield. The bad news is that $800 million in capex this year will probably use up all of the company's cash flow, and perhaps even require external financing.

Based on past experience, though, the investments could soon begin to pay off. Since 2003, each dollar of capital expenditures in one year has increased the cash from operations in the subsequent year by an average of 31.7%. Even if this year's capital expenditures are toward the low end of previous results, the free cash flow position could be restored in 2009.

Analysts have certainly started to take notice. In the last 90 days, the consensus estimate for 2008 earnings has risen to $3.62 a share from $2.56. For 2009, estimates have gone to $4.05 from $2.92. While volatility in price and production levels can cause wild quarterly valuations, the trend has lately been in WTI's favor. After missing estimates by 34% in the March 2007 quarter, the company's last three earnings reports have averaged a 34% positive surprise.

On a valuation basis, WTI is trading at about 2.7 times book value, which is roughly in line with the industry average even though the company's growth and return on equity are above average, according to Zacks' Research Wizard. W&T Offshore's growth, combined with modest valuation expansion, could lead to annual returns of 15% to 20% over the next several years.