This Oil Company Has Huge Potential

ATP Oil & Gas (NAS: ATPG) is a heavily shorted stock, with more than 38% of its outstanding shares shorted at the time this article was written. While this makes for a good "short squeeze" call, I am a firm believer in investing by studying the fundamentals of a company. Here is my due diligence, weighing the company's pros and cons to see if it is a worthy investment.

Formed in 1991, the Texas-based company has been acquiring and developing oil and natural-gas properties in the Gulf of Mexico and the North Sea. Last year the company acquired licenses to operate in the gas reserves of the Mediterranean Sea off the coast of Israel. The company had estimated net proved reserves of 118.9 million barrels of oil equivalent at the end of 2011.

Approximately 75.9 MMboe of the total reserves are in the Gulf of Mexico, and almost 74% of proved reserves in the area are yet to be developed. Following the Deepwater Horizon disaster in 2010, the enforced ban saw many small-cap energy and petroleum companies operating in the Gulf struggle. The moratorium on drilling in the Gulf of Mexico is easing, and that's the biggest reason why ATP looks like a buy.

The company can now go back to business as usual and pull out those massive reserves. Peers working in the deep waters of the Gulf have also ramped up developmental activities. Noble Energy (NYS: NBL) has six projects under way, and production is due to come online in the first quarter this year. Similarly, Energy XXI (NAS: EXXI) , using its "acquire and exploit" strategy, has positioned itself to significantly ramp up production in the next few years. The Davy Jones play, one of its more promising fields, is almost ready for production. ATP is capable of the same, and the signs of a production hike look promising. Given current oil prices, they stand to make a lot of money.

There are two reasons to make this argument: very high leverage and faltering production. With just $65 million in cash and total debt at almost $2 billion, things do not look so rosy from a financial standpoint. The debt-to-equity ratio stood at 712%, and the current ratio is an unenviable 0.4 time. The company is also burning cash at a frenzied rate and may face serious liquidity problems if production falls. A case in context is GMX Resources (NYS: GMXR) , whose huge debt has seen its stock get hammered, falling 74% in the last 12 months. More recently the company successfully completed drilling on its fourth well in the Bakken shale, and share prices rocketed 33%. Production growth, I feel, is a must for ATP.

ATP has significant reserves and is increasing production. In February it brought its fourth well online in its Telemark Hub field in the Mississippi Canyon Block. Production at the Telemark Hub increased an astounding 191% in 2011 from the previous year, while overall production in the Gulf grew by a slower 54% due to the moratorium.

Secondly, the proportion of liquids in total production grew to 68% from 58% in 2010. This bodes well, especially since the market for natural gas has yet to pick up, while oil prices continue to hover above the $100 mark. Total revenue has been the highest in the last five years, and free cash flow has turned positive as well in 2011. That is definitely encouraging.

Third, the company is raising $500 million through a mixed offering, including senior debt. This should take care of ATP's working capital needs as it strives to develop its properties and add to production. The fact that there are takers for its debt, despite its leverage, speaks volumes about the potential of the company.

The Foolish bottom line
I would love to see the company turn around and post profits. Given the potential it has, I would hold on to the stock, despite the odds, and even think of increasing my position, given it's trading a lot cheaper than it was a year ago.

Oil stocks are what I'm interested in, and if you're looking for more ideas in the industry, take a look at this special report: "3 Stocks for $100 Oil." It's absolutely free for a limited time.

At the time thisarticle was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article.The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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