The price of oil has surged more than 60% since 2004, and I believe that
consumers waiting for a permanent price drop have lost their senses. Look no
further than Asia for the explanation: By 2010, China is expected to have more
than 250 million middle class citizens, who will whiz from Shanghai to Beijing
to Chengdu in automobiles. (Let’s hope they’re more fuel-efficient than the
guzzlers we’ve been driving.) As entrepreneurial capitalism continues to spread
throughout the world, the demand for natural resources will only rise.
Unit Corp. (NYSE:UNT), a contract driller operating primarily in Oklahoma
and Texas, is perfectly positioned to benefit from the world’s insatiable demand
for oil and natural gas. It is one of the 10 most highly ranked stocks by our
Motley Fool community, and I believe we’re looking at more than a double over
the next five years.
The roots of Unit’s business go back to 1963, when King Kirchner borrowed
$150,000 to buy the Unit Drilling division from Woolaroc Oil. At the time, the
division had three drilling rigs and three employees, including Kirchner. Amid
warnings from his father and grandfather that oil’s best days were in the past,
Kirchner chose to stick with the drilling business.
Today, along with its contract drilling business, Unit engages in the
acquisition, exploration, and development of natural gas and oil properties — as
well as buying, processing, and selling natural gas. Contract drilling, the
fastest-growing division of the company, contributes 60% of the company’s
revenues (mostly from natural gas) and two-thirds of its operating income. The
company now operates 118 drilling rigs in places ranging from Casper, Wyoming,
to Houston, Texas, with a strong concentration in resource-rich northern Texas
and western Oklahoma.
Since 2001, Unit’s revenues have grown nearly four fold, and net
income has grown at a compound annual rate of more than 31%. During the past 12
months, the company crossed two significant milestones: It reached $1 billion in
revenues and $300 million in net income. Returns on capital and total assets
have followed suit with record highs. Driving these revenues is an asset base of
$1.9 billion, most of which is in proven gas reserves.
In 2004 and 2005, Unit’s stock was climbing fast. But it stalled last year due
to growth and pricing concerns. Investors got scared, and now we have a stock
selling at a price-to-earnings multiple of eight (significantly less than the
industry average). Near-term growth rates are sluggish, but five-year growth
projections tilt optimistically north of 20%. And there’s even more to this
story.
Let’s turn back to those proven gas reserves. The company finished 2006 with
slightly more than 400 billion cubic feet to call its own. If I account for some
price drops (I certainly don’t pretend to know where prices are heading) from a
bit over $7 per thousand cubic feet (Mcf) to $5 — and add in the extraction
costs of $2 per Mcf — then I estimate the value of these reserves to be about
$1.2 billion. This means we get the other two businesses (contract drilling and
gathering) for about $1.8 billion, or just about five times what they will
generate in operating profit this year. (The gathering division is just starting
to pick up.) Even if I normalize for more conservative estimates, I think Unit
will be at least a $6 billion company by 2012 — a company that will deliver
annual returns of more than 16%.
I can’t discuss a gas and oil company without mentioning
the sector’s volatility. Gas prices in particular have been on a roll for the
past few years, moving from about $3 per Mcf in 2002 to nearly $7 today. This
increase opened the door for immense investment in building rigs, buying wells,
and making acquisitions. But even if gas prices fall by a dollar or so, I think
Unit can still generate plenty of cash to operate its business and cover its
debt payments.
Unit has enjoyed a tremendous run over the past few years, but I think we’re
just seeing the beginning of what this company can do. It stands to benefit from
the continued and seemingly insatiable demand for natural resources. It may not
take us on the smoothest ride (as we bump along with mercurial gas prices), but
ultimately, I expect this energy company to strike gold for shareholders down
the road.
