Fundamental and Technical Analysis of Encore Acquisition (EAC)

Encore Acquisition (EAC

EAC is small independent exploration and production company with operations and reserves solely in the United States.

The company is ten years old this year, as it was founded in 1998.

EAC is in the GEA portfolio and is one of our oldest holdings (originally recommended in January 2005.) We like EAC because of its high oil to gas ratio and the low market value of its reserves.

Prior to 2007 the company had difficulty meeting production guidance and the stock price reflected its problems.

This year the company has surprised everyone with higher production and with record high energy prices, they have handily beat Wall Street earnings estimates. They will probably continue to have excellent earnings over the next few quarters and Wall Street has dramatically increased their earnings estimates. We’re more interested in EAC’s cheap reserves versus its earnings.

The market value of their proved reserves is approximately  $17.65

Below is an analysis of its reserves.

The information is from EAC’s 2006 annual report.

Let’s review the table:

- The first row lists EAC’s proved reserves of 204.56 million barrels of oil equivalent (BOE, a combination of crude oil and natural gas.)

- The second row breaks out the amount of crude oil reserves EAC has and it has approximately 153 million barrels of proven reserves of crude oil.

- The third row lets us know that the oil to natural gas reserve ratio is a high 74.79%. Again, EAC has one of the highest oil to gas ratios of the companies we follow.

- EAC finding and developing, F & D, costs are $15.87 per barrel and the market value is close to its costs, $17.65. We consider the company undervalued based on the potential future price of oil and the low market value of its reserves.

The market value of its reserves does not consider its probable and possible reserves, another case for its undervaluation.

- The sixth column tells us that at current production, EAC’s reserves will last approximately 18.19 years.

- The last column is the replacement ratio of the oil based on what was produced for the year. EAC’s replacement ratio for 2006 was 179%.

Technical Analysis of EAC

Below is a long-term chart of EAC:

The stock more than tripled the first few years of the energy bull market and peaked in 2005. The stock then went sideways for almost 3 years.

The stock exploded to the upside on stronger than expected earnings growth this year, as mentioned above.

Below is a shorter term chart of EAC:

Let’s review the chart:

- Even after a parabolic move, there is little profit taking, so it may digest/consolidate its upward move.

-The choppiness indicator has moved below 30 indicating the current rally is over. The indicator is also heading up suggesting prices will consolidate.

- Notice how the short position (first pane) has fallen by 50%. Besides excellent earnings that brought buyers to the stock, the stock also had a short squeeze.

The next earnings report is expected July 28^th. The consensus earnings forecast has increased dramatically to $1.28 versus last year’s earnings of 44 cents. This is probably why there is little selling in the stock.

We bought the stock at $21.50 (price adjusted for 3/2 split), and we have written options against the stock, and now have a cost basis of $6.80.

We have written a June $25 option against the stock before the move up. Since time is on our side we can continue to write options against the stock , but we’ll have to roll up our strike prices. We will do this closer to June option expiration to let the time value decay.

Earnings growth will probably slow a year from now as the earnings comparisons become more difficult. We’re sure the market will figure this out soon. Once prices find their peak, prices may go sideways until the next higher trading range for oil is determined.

EAC is attractive, as the market is pricing its reservea at less than $18 a barrell. The futures market has oil priced above $130 a barrel.

 We will stay with our old buy price for the GEA portfolio and won’t add to our positions, unless there is a significant correction.

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