Jonathan Moreland

Soaring Prices Get Insiders Pumped Up

Here’s why.

June 16, 2008
by Jonathan Moreland

[DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.]

As some CPA Insider™ readers may not know, shares of TXCO Resources (NASDAQ: TXCO) have performed solidly for my InsiderInsights newsletter’s “Recommended List,” and have also had several clusters of insider buying activity during the 65 weeks I’ve held them. One of those buying clusters happened last month as TXCO dipped down from its recent highs, and I agree wholeheartedly that TXCO is again offering an attractive entry point.

TXCO is an oil and gas exploration firm focused on the Maverick Basin in Texas. Nearly 70 percent of its production last quarter was oil rather than gas — a much more lucrative commodity these days. This decades-old firm is betting that new drilling technologies will allow it to exploit hard-to-get hydrocarbons profitably from the likes of shale formations and tar sands on its Texas concessions.

TXCO’s tar sands opportunity is representative of what has made this stock increasingly more interesting since I entered it. The firm has spent decades building up exploration rights on around one million acres in and around Texas, when doing so was cheap because of the relative difficulty of exploiting them. For instance, the company got rights from ranchers in the tar sands region way back in 1999, when oil was still cheap enough to keep the Canadian tar sands project unviable.

But exploration and production (E&P) technology and energy prices have since gone TXCO’s way. The combination has made both its tar sands acreage, and its shale gas play acres in Pearsol not only viable, but also attractive. Meanwhile, TXCO has already made technology work for shareholders by using it to wring cash flow out of its Glen Rose porosity oil play.

On the surface, the promise is also playing out on the firm’s income statement. Revenues in 2007 rose 30 percent year-over-year, to $93.9 million. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) increased 42 percent, to $52.9 million. Q1 results continued this growth trend. Revenues nearly tripled year-over-year, to $32.2 million in the period.

Of course, year-over-year growth metrics have been bolstered in the past several quarters due to TXCO’s acquisition of privately held Output Exploration in April 2007 — a distortion that made its final appearance last quarter. But it was still notable that Q1, which is usually the seasonally weakest for TXCO, had sales that were a tad higher sequentially as well. Also positive was that EBITDA surged more than four-fold, to $19.2 million. That’s a larger rise in cash flow than sales. The company must be doing something right.

Alas, there is not enough going right to please everyone. Activist Daniel Loeb’s Third Point LLC picked up an eight percent stake late last year, and he put a voice to the disappointment that was obvious in the price action of TXCO’s shares in the wake of the Q1 results.

“Frankly, we are pretty frustrated over here and would like to know what you are doing specifically to address the significant production problem,” prodded Loeb. “You are sitting on some tremendous assets,” he continued. “We all understand the potential here, but we are just frustrated that this potential is not being realized.”

So despite the uncertainty of how much production can get on line when, the trend in the large range of estimates is up. And despite valid concern of a critical shareholder like Loeb, he believes enough in the asset quality of TXCO to commit (verbally, at least) that his group is “not going anywhere” and “will be long-term shareholders.”

Realizing the value of TXCO’s concessions is a matter of “when” not “if,” and I view insiders buying their share’s dip last month as confirmation that the same opinion is held by many in TXCO’s board room. The troika of directors invested another $474K in their stock at an average price of $10.54. Bolstering the strength of the insider signal, the $264K investment by director Dennis Fitzpatrick last week was more than double the dollar amount he spent buying shares last December. He’s seemingly more bullish now than before. Another in the recent buying cluster, director Michael Pint, has also been a shrewd buyer and seller of TXCO during his more than eight-year involvement with the firm.

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Jonathan Moreland is the Director of Research at New York-based InsiderInsights.com. View a FREE trial issue of the firm's weekly newsletter InsiderInsights.