Don't Be Misled by Kodiak's Latest Numbers

When analyzing oil and gas companies, what I find most important are their underlying business and long-term growth prospects. Hence, it doesn't really matter if circumstances like fluctuating oil prices obscure a given company's long-term prospects. The latest quarterly results from Kodiak Oil & Gas (NYS: KOG) don't seem too impressive as far as its bottom line is concerned. However, that looks like a mere aberration, rather than a serious fundamental problem.

The latest numbers
For the first quarter this year, net income came in at $1.7 million, compared to a net loss of $7.2 million in last year's first quarter. For some, a bottom line that barely manages to reflect a profit isn't the best way to boost shareholder confidence given the attention this stock gets. However, revenue from oil and gas sales grew a whopping 499% to nearly $80 million. This isn't really surprising, considering that sales volumes jumped 473% year-over-year.

Investors should take note
Unfortunately, two things went against Kodiak. First, the exploration and production company had substantial depreciation expenses of around $26 million this quarter, thanks to major acquisitions in the last six months. Last October, Kodiak acquired 13,400 net acres in the Williston Basin, followed by another 50,000 net acres in January. While these new acquisitions increased Kodiak's net acreage by a massive 60%, initial deprecation costs shot through the roof, taking accounting procedures into consideration.

But what's interesting to note is that out of Kodiak's total holdings of 168,400 net acres containing proved reserves, only about 69,000 net acres (or roughly 41%) are developed and contribute to production. However, for accounting purposes, depreciation and amortization costs are calculated for the entire holdings. Practically speaking, this just doesn't make sense. Investors need not be bogged down by these notional costs. The good thing, however, is that management needn't be bothered by these costs later. With almost 60% of Kodiak's proved reserves yet to be developed, the company's production potential is simply huge.

Another paper loss
Second, higher crude oil prices in the first quarter meant that Kodiak made further notional losses of $23 million due to hedging of oil prices. Out of this, $18.6 million is still unrealized. In any case, these losses only indicate the amount that Kodiak could have made, and by no means indicate any real losses suffered through cash leaving the building. Another leading Bakken player -- Continental Resources (NYS: CLR) -- is a fine example of an E&P company making paper losses due to hedging strategies, but otherwise is a solid company from a business standpoint. Not surprisingly, its stock has returned a fantastic 78% in the last 24 months.

Foolish bottom line
To sum it up, Kodiak's cash flow from operations shot up an amazing 686% from last year's first quarter and 424% from the previous quarter. One of the early operators in the Bakken, this company is still reaping the harvest. But make no mistake; the best of Kodiak is yet to come. My gut feeling says that the stock is still undervalued. I believe we've yet to witness the company's full potential. Meanwhile, you can keep abreast of the situation by adding Kodiak Oil & Gas to your free personalized watchlist.

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

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