Investors have picked over the oil patch in recent years, but there's still value in small oil and gas outfits. Barry James, manager of the excellent James Small Cap Fund, loves Vaalco Energy (symbol EGY), a $7 stock whose total stock-market value of $400 million would fit inside ExxonMobil a thousand times.
Vaalco is a Houston-based exploration, development and production company. Its operating numbers first brought Vaalco to James's attention: net profits that have quadrupled in two years, a towering return on equity of 43% and a modest price-to-cash-flow ratio of 10. James then checked further and found that the story gets better.
Vaalco was controlled by an oil and drilling trust which expired in March 2005. In the run-up to being wound up, the trust prevented the management from taking any risks, so capital accumulated within the company. With the shackles off, Vaalco can turn aggressive again.
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It also happens that Vaalco has strong seismic imaging know-how and quite a track record of finding oil and gas in West Africa. The company's main production field is off the coast of Gabon, a stable nation. Vaalco pumps oil there for $5 to $7 a barrel, says James, and sells it at or just below the benchmark world price for crude. Later this year, Vaalco will start producing from a second offshore Gabon field. It will also get some oil from a third field on Gabonese soil.
These are small fields in an obscure location, but James notes that they can still be highly lucrative to operators the size of Vaalco although of no interest right away to the oil giants. "If there are under 100 million barrels of projected reserves in a field, Shell or Exxon won't touch it," says James. However, if this nimble outfit continues its success in Africa, the fund manager figures some larger oil company may bid to buy out Vaalco.
This stock traded for $3 to $4 until a few months ago and is not for the faint of heart. But if James is correct in his analysis, it has more room to run.
--Andrew Tanzer
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