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Wednesday, June 16, 2010

Time to buy -- little known small cap could be Gulf of Mexico value stock

I've been dabbling with applying some of our Swing Signals algorithms to weekly data. This past weekend I came up with an interesting stock that generated a Strong BUY signal. The company is Energy XXI (Bermuda) Limited (EXXI).

Background --

The company engages in the acquisition, exploration, development, and operation of oil and natural gas properties onshore in Louisiana and Texas and offshore in the Gulf of Mexico.As of June 30, 2009, it had proved reserves of 53.1 million barrels of oil equivalent, as well as operated or had an interest in 274 producing wells on 148,784 net developed acres.

With all the negative publicity around companies that drill in the Gulf of Mexico, it's a bit of a surprise to see a company like Energy XXI beginning to register gains in its stock price. What seems to be happening is that investors are beginning to discriminate between deep water drillers and shallow water drillers. Energy XXI drills in waters only 100 feet deep. The company tends to drill very deeply into the continental shelf but the fact that the waters are not deep lessens the chances of the kinds of accidents that can happen in deep water, reduces complexity and also allows the blowout preventer (amazing that we all know what that term means now) to be located on the rig itself rather than a mile below the surface of the ocean. Costs at these ocean depths are much cheaper than the costs incurred to drill in deep water and the company is reputed to have tapped into supplies of natural gas that could amount to hundreds of trillions of cubic feet gas equivalents.

The financials --

With a market cap of $877.92M the company is considered a small cap stock. It's PEG is only 0.66 and its Enterprise Value/EBITDA ratio is only 4.6. Both of these values are deep in the value range and the price-to-book and price-to-sales numbers also suggest the stock is not over-priced.

The company was free cash flow positive in its most recent quarter. Cash flow yield as calculated at Trade-Radar was 30% which is pretty darn good. Revenue in the most recent quarter was up strongly on a sequential basis though earnings were not. Return on equity is over 13% and return on assets is over 6%. Taken together this is good but not great.

Beta of 2.64 implies that investors could be in for quite a ride. Now that markets seem to be rallying, that could be a real advantage for holders of the stock.

The chart --

Here's why we think the stock could be a Strong BUY from a technical perspective.

Williams %R and Slow Stochastics show a BUY signal in progress. Bollinger Band analysis implies there is a good chance that a real reversal is underway. A powerful indicator that a good bounce is happening is the fact that the 50-week moving average is still intact and pointed nicely upward.

Conclusion --

This small cap shows there are values available in Gulf energy companies. This could be a case of investors throwing the baby out with the bathwater. Negativity around Gulf of Mexico energy companies has tainted this stock but their story is quite different from that of BP, for example.

The potential holdings of Energy XXI are attra ctive and the level of risk is much lower than that of the deep water drillers.

With the chart showing a bounce in progress, this is a good time to consider the stock.The numbers suggest the company is far from over-valued and as the economy slowly strengthens, the fortunes of energy companies will likewise improve. Looking at the chart and the financials, it's possible to project that this stock could reach $35 to $40. With the stock closing at $17 and change today, an investor could realize a nice profit over the next six months to a year.

Disclosure: no positions

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