Bottom of the Barrel: Drilling Into Energy Partners

Energy Partners' drilling program has accelerated dramatically in the past several months. It now has eight rigs working in the Gulf of Mexico, with a ninth on its way to a site today. The company has promising developments in such prolific Gulf of Mexico fields as East Bay, East and West Cameron, Eugene Island and High Island.

Financial Stewardship

Another attractive facet of Energy Partners' story is its financial shape. It's very focused on returns on capital, very cognizant of its production costs and relatively conservative with its use of debt.

Although its debt jumped when it acquired Hall Houston, its current debt-to-capital ratio is only 32%, well below the peer average of 41%. If CFO Suzanne Baer has her way, it will remain that way.

"You won't see that number go above 40%," Baer said. "The industry is volatile enough not to add more risk through debt."

That kind of conservative financial management is a very positive sign from sometimes-aggressive E&P companies. Along with a very disciplined hedging program that provides a level of cash flow predictability, Energy Partners' financial model should continue to steer the company clear of major trouble.

En-Gulfed Energy Partners bets on Gulf of Mexico natural gas
Year	Revenue (millions)	Earnings Per Share
2001	$145.90	$0.49
2002*	125.00	(0.38)
2003*	NA	(0.10)
*Estimated. Source: First Call, company reports, TSC research

Dry Holes

However, Energy Partners isn't without meaningful risk. It is, after all, a small-cap E&P company, where the cost per exploratory well relative to the company's size is significant. A string of bad luck with dry holes -- this year, the company is batting more than 75% -- could hurt its production and cash flow growth.

In addition, a decline in natural gas and oil prices could impact the company's margins. Although its production costs remain relatively low (about $9.78 per barrel of oil equivalent), slipping commodity prices may make risk-reward decisions on where to drill more difficult. The company's hedging program, however, should help manage that impact.

Finally, Energy Partners is expected to report a per-share loss of about 38 cents this year and 10 cents next year, adding a bit of speculation to the play. However, cash flow continues to increase and should largely fund new opportunities in the coming year.

Energy Partners has a good management team with good prospects and good operators finding plenty of opportunities to harvest natural gas in the Gulf of Mexico. Any small-cap exploration play is highly speculative, but Energy Partners is worth a look, especially given its relatively healthy financial profile.

After the stock's recent rally, investors may want to pick their entry point at slightly lower prices, but longer term, this is a small-cap E&P name I like. I give it three barrels. (For an explanation of our barrel rating system, see our description.) Energy Partners rose 22 cents, or 2.4%, to end Wednesday's session at $9.40.