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5 reasons to be bullish on Drillsearch

One big concern for investors when considering small resource stocks is will the company’s talk about future production actually turn into revenue and how long will that take. Approvals and feasibility studies can take years by themselves, and still you have to wait for the development and construction phase before major revenue can be achieved.

The story definitely brightens once a certain stage of production and earnings can be achieved. Now the company can cover its running expenses, and may even be able to afford further expansion and exploration.

That’s where Drillsearch Energy (ASX: DLS) is at now. With its 2013 NPAT before abnormals of $54 million, rising from $9.98 million in 2012. In 2013, production was 1.1 million barrels of oil equivalent (mmboe), rising 173% from 2012.

I have five reasons why the Drillsearch story is bullish.

Higher production, higher revenue

Before, like many junior resource companies, each year’s results could move from positive to negative because revenue was low and unstable. After 2010 revenue went from $14.4 million to a little over $102 million in 2013.

Production expansion and earnings growth

Nothing says success better than earnings, and you can expect the earnings will be higher than the forecast $30.7 million EBIT in 2014. That amount is based on the company’s forecast production of 2.3-2.5 mmboe.

Unconventional gas opportunities

Drillsearch’s operations are all in the Cooper basin, a region straddling the SA-QLD border, which has been producing oil for decades. Recently, the region has been an unconventional gas story. This adds another layer of potential revenue that Drillsearch can tap into with new technologies to extract oil and gas from coal seam, shale oil and tight gas. Even US energy companies are starting to look at the region for its wealth of opportunities.

Development joint ventures

Drillsearch is teaming up with Santos (ASX: STO) to accelerate the development of multiple wet gas discoveries. It also has joint ventures with other local energy companies like Beach Energy (ASX: BPT) and Origin Energy (ASX: ORG) within the South Australia Cooper Basin JV. The joint ventures should further spur on production.

Pipeline access and export sales

The company’s oil and gas is not stranded out in the middle of nowhere because major pipelines and processing plants are close by in Moonba, SA. So with the sales agreements and separate pipeline joint ventures, it can tap into existing infrastructure to deliver oil and gas to customers in eastern Australia, or to foreign markets, when the current LNG developments in QLD are complete and are ready to take on LNG processing in places like Gladstone.

Foolish takeaway

In 2013, when revenue and earnings expanded immensely, the company also borrowed $129 million. Further development and expansion will cost money, but when I look at the ratio of long-term debt to earnings, telling me how quickly the debt could be paid off in full, the $129 million is about 4.7 times the 2013 $27 million pre-tax profits. That means theoretically the company could pay off the loan in under five years.

Gross gearing is about 48% and its current ratio (current assets/current liabilities) is 1.67, so it is still in a stable financial position. With expected production increases, the company has a stable growth plan and bright future.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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