Small Stocks, Big Gains in the Oil Patch
"We conducted our most extensive due diligence on GMX Resources, its management and its partners when compared to all other E&P companies under coverage," Hibernia analyst David Heikkinen wrote. "The justification for our intensive due diligence was to determine if the company had any risks beyond the lawsuit against Nabors Drilling that was settled in May 2003."
While scouring court records and other public documents, Heikkinen uncovered no material legal problems. He still describes GMX as "an emerging company with limited capital resources." But GMX's joint venture with Penn Virginia has left him optimistic about the company's future.
"GMXR has an impressive inventory of drilling locations that we believe will add reserves, production and net asset value as the company accelerates their drilling heading forward," Heikkinen wrote. "We believe the company is well positioned with its joint-venture partner to significantly grow reserves and production between now and 2006."
Shares of GMX, while down 1.4% to $7.02 on Friday, have more than quadrupled over the past year.
Future GainsChernoff sees plenty of upside left. "The market is still treating GMX as a dubious company that's had litigation problems and mediocre reserves," said Chernoff, who owns GMX himself. But "everything is setting up for a big, big gain in the value of the company." Because GMX is now actually drilling, Chernoff says, the company can simultaneously expand both its energy production and its proved reserves. He expects the company's production and cash flow to increase "rapidly" -- starting this quarter. In the meantime, the company itself has already cast a strong vote of confidence in its future. In a brief announcement earlier this month, GMX laid out plans to repurchase warrants that, until early 2006, can be exercised at $12 a share. "Why would a company with a stock price of $7 do this -- especially when they need money for drilling?" Chernoff asked. "This indicates they expect their own stock price to be over $12" before issuing new equity next year. Chernoff is convinced that the market will eventually recognize GMX's true value as well. The company's "exchange of working interest to Penn Virginia for equity and accelerated drilling is an excellent trade," he said. "It perfectly positions GMX to drill and prove up reserves on the remainder of its acreage, where it has retained as much as a 100% working interest." So "GMX gets a smaller piece of a much larger pie -- and a much larger valuation once the market realizes the size of the pie."
Repeat WinnerChernoff's second pick, Encore, has already proven itself. While young like GMX, Encore enjoys a much larger market value -- exceeding $1 billion -- and a profitable history. The company makes money by snatching up depleted fields on the cheap and then using technology to extract leftover oil from the properties.
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