How to Separate the Risky From the Safe in the Oil and Gas Sector

NEW YORK (The Deal) -- Now that oil prices seem to be steadying at about $60 per barrel, investors may be tempted to dip back into oil and gas stocks.

Anyone feeling that urge, however, needs to consider what constitutes risk in the industry.

According to KLR's model, Cabot Oil & Gas (COG), Memorial Resource Development (MRD), Diamondback Energy (FANG), RSP Permian (RSPP), EOG Resources (EOG), Parsley Energy (PE) and Synergy Resources (SYRG) have the highest combined cash recycle ratios and the lowest financial leverage.

It is an impressive lot. Cabot, led by Dan Dinges, is a top operator in the Eagle Ford in South Texas and the Marcellus Shale in northeast Pennsylvania and is considered to be a potential takeover target.

Memorial Resource Development, headed by John Weinzierl, owns properties in northern Louisiana and many analysts, including Tudor Pickering Holt & Co. Securities, consider it significantly undervalued on a 2016 enterprise value-to-EBITDA basis compared with its peers.

"We see 46% upside compared to the peer average of 29%," Tudor Pickering Holt wrote on June 5.

And Diamondback, led by Travis Stice, operates in some of the best spots in West Texas' Permian Basin, including the Wolfcamp, has one of the better reserve replacement records in the industry and is oft mentioned as a potential acquisition candidate.

RSP Permian, as its name would suggest, is also big in West Texas, particularly the core of the Midland Basin, and the Steven Gray-led company has been considered an attractive target for Diamondback. EOG Resources, which was Enron Oil & Gas in an earlier stage of its existence, is led by Bill Thomas and is nicely diversified with good properties in several different basins.

The company has been rumored to be a target of Statoil (STO). Parsley, led by Bryan Sheffield, focuses on the Permian Basin and is also a takeover candidate (especially after Noble Energy's (NBL) pickup of Rosetta Resources (ROSE) for $3.9 billion).

And Synergy, headed by co-Chief Executives Ed Holloway and William Scaff, concentrates on the Rockies, has one of the sector's best reserve replacement ratios and is expected to pick up properties from pained rivals. Last month, it hired Kodiak Oil & Gas (KOG) founder and Chief Executive Lynn Peterson as its president (Kodiak was purchased by Whiting Petroleum last year for $6 billion).

So where is the highest risk? That list includes SandRidge Energy (SD), Comstock Resources (CRK), W&T Offshore (WTI), Goodrich Petroleum (GDP), Energy XXI (EXXI) and Halcón Resources (HK).

The names aren't all that surprising, as they are all struggling with high debt loads that were taken on during better times.

SandRidge Chief Executive Jim Bennett has said the company is considering several options to reduce its indebtedness and boost liquidity, from asset sales to forming master limited partnerships that would hold some of its assets (its properties are mostly in the mid-continent). Comstock, led by Miles Jay Allison with assets in South Texas and East Texas/northern Louisiana, had a wider loss than expected in the first quarter, and many think it should be looking for a merger partner.

Tracy Krohn's W&T Offshore, which owns properties in the Gulf of Mexico as well as the Permian Basin, has been trying to sell assets through the malaise and is thought to be a target after Royal Dutch Shell's ( RDS.A) $70 billion purchase of another offshore player, BG Group.

Goodrich, headed by Gil Goodrich and concentrated in the Tuscaloosa Marine Shale, the Eagle Ford Shale and the Haynesville, should also be looking for a partner, analysts say.


Ditto for offshore player Energy XXI, John Schiller's company that has been trying to sell offshore properties but isn't getting the price it wants. And then there is Halcón Resources, the Bakken and Eagle Ford Shale explorer led by the legendary Floyd Wilson that has had bankruptcy rumors swirl around it (Halcón Resources and SandRidge Energy both completed bond-for-equity exchanges in May below par).

Buying into these names will require a high tolerance for uncertainty.

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