Are Beach Energy and Aurora Oil and Gas set to soar?

These two resources companies may deserve a place on your watchlist.

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A lot has been written over the past year or so about oil and gas producers such as Woodside Petroleum (ASX: WPL), Beach Energy (ASX: BPT), Aurora Oil and Gas (ASX: AUT), Oil Search (ASX: OSH) and Santos (ASX: STO). With global oil eventually running out and experts predicting a natural gas boom, the stage appears to be set for a rise in these companies' prices, but it hasn't happened yet.

Oil Search, Woodside and Santos all rose between 10-27% in the last 52 weeks, broadly in line with the ASX, which delivered around 15%. However the two smallest producers of this group, Beach Energy and Aurora, actually dropped in price, by ~7% and 20% respectively.

Given that the fundamentals of these two companies actually improved substantially in this time, this presents an opportunity for buyers with a keen eye for value.

Beach Energy is the lowest priced and smallest of these producers, delivered record revenue in FY2013 and has a new record in its sights for FY2014. Beach is aiming to increase production by a further 10-16% for 2014 and appears on track to meet this target. With its primary wells located in the Cooper Basin in South Australia, Beach also has a number of prospective wells in Romania, Tanzania and other exotic locales. Beach is partly insulated by any problems with its fields by its geographic spread and co-ownership strategy, although any problems with its Western Flank oil fields will still significantly cramp revenue. Likewise if the expected success with its Eastern Flank exploration doesn't appear, future revenue growth may not occur as fast as expected.

Aurora Oil and Gas operates and is junior partner in a number of wells in the Sugarkane field in Texas, USA, and produces its earnings in US dollars, which is currently a positive for an ASX-listed company. Aurora is set to increase production by 47% this year to 7.8-8.6 (net to Aurora) million barrels of oil equivalent, and the market is apparently ambivalent to the news, which presents buyers with an opportunity. As Motley Fool writer Andrew Mudie notes, at its current price, Aurora is potentially trading at a price to earnings valuation of 7 – quite low given the scope of the earnings increase that should occur this year.

Aurora Oil and Gas presents the greatest upside to investors for 2014, however as market analyst Morningstar notes, Aurora remains "an all-or-nothing bet on its Eagle Ford shale holdings in Texas and it is a minority, non-operating partner in the vast majority". Aurora is also constrained by geography, with its fields all located in one area and unlikely to be expanded owing to fierce competition for space in the Eagle Ford oil fields. Aurora also has considerable debt, although as production grows this year and capital expenditure decreases, this will hopefully become less relevant.

Beach Energy provides a lower potential upside, although greater potential for long-term profit growth as it begins production overseas and also begins selling gas to Origin Energy (ASX: ORG) in 2015. Beach Energy is also afforded more protection by its greater number of wells in which it is the predominant operator, as well as the fact that it carries zero debt and $400 million in cash. Beach also pays a small, 100% dividend worth approximately 2% of the share price.

Foolish takeaway

The gains offered by oil and gas producers need to be placed in perspective; these are high-risk (although I wouldn't call them 'speculative'), high-reward shares. The real upside in oil and gas shares is in their potential for profit growth and capital gains. Given that these two shares also appear undervalued by the market, investors are essentially being offered two bites at the apple.

I've been looking for an oil and gas producer to add to my portfolio and Beach, with its geographical diversification, apparent value, dividend, and lack of debt, is my personal choice (and not coincidentally, my latest acquisition).

 

Motley Fool contributor Sean O’Neill owns shares in Beach Energy.

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