As gasoline use falls, Wayzata firm profits in oil

Gasoline consumption has fallen off dramatically domestically and around the world during the recession. But in North Dakota and surrounding states, a Wayzata-based company continues to pump up its balance sheet by participating in the exploration and drilling of newly discovered oil and gas deposits.

Northern Oil and Gas (NOG) has only been active in the energy exploration process for about two years, but it expects to have a stake in about 100 drilling projects within the next year. "We expect them to experience dramatic profit growth in the next few years -- even if oil stays at $50 a barrel," explains Charles Mahar, president and CEO of Minneapolis-based Tealwood Asset Management. "We think the company is two years away from earnings of more than $2 a share, and its stock has been trading at just over $9 a share."

Northern Oil and Gas does not actually do the drilling. Rather, it leases mineral rights in strategic locations in the Bakken and Sanish shale formations, primarily in North Dakota and Montana. It also helps pay the exploration and drilling costs. In return, it receives a share of the proceeds from the oil and gas produced.

"The company has had a 100 percent success rate in the projects it has been involved with -- and that's unheard of in this business," says Dan Aronson, Tealwood vice president. "Their costs are probably about $20 a barrel for drilling and transportation and they can sell the oil for about $50 to $70 a barrel, so their economic model is very profitable. And they only need five professionals to run their core business."

Mahar cites Northern Oil and Gas as a prime example of the type of stock that should continue to perform well in the next stage of the stock market. "Over the past couple of years we've seen the whole market -- good stocks and bad -- fall together and recover together. But going forward, it's going to be important to focus on specific stocks that have exceptional long-term expansion capabilities."

He said he looks for companies with what he considers to be the two most important variables: solid profit growth and a low price-to-earnings (PE) ratio. "In other words, we're looking for cheap stocks with high profit growth potential."

Mahar says the main reason stocks have performed so poorly in this decade compared with the 1990s is due to lower earnings and valuation levels. "We've seen 3 percent annual profit growth in this decade for Standard & Poor's 500 stocks, compared with 12 percent profit growth in the 1990s. Along with that, we've seen a 50 percent drop in price-earnings ratios."

Patterson Companies (PDCO). The Mendota Heights-based operation is a distributor in the dental, veterinarian and rehabilitation supply markets in the United States and Canada. Its primary business is dental supplies, including such items as X-ray film, instruments, protective clothing, toothbrushes and related supplies. It also distributes lab supplies and related medical items for the veterinary business, as well as rehabilitation equipment and software. "Patterson is one of the companies we expect to continue to do well, with annual earnings growth of about 12 percent for the next two years," Mahar said. Patterson was recently trading at $25.87, up dramatically from its 52-week low of $15.75. It has a PE of about 15. It pays no dividend.

Dolan Media (DM). The Minneapolis-based operation publishes information for the legal, financial and real estate markets. "About 65 percent of its revenue comes from legal services for the foreclosure business," says Mahar, "And they don't expect that business to peak until 2011." He expects the company to have a 70 percent increase in profitability in the next year based on free cash flow. He also believes that the stock, which recently traded at $11.25 share, could reach the high teens next year. The stock, which has a PE of about 23, is up dramatically from its 52-week low of $2.45.

Ormat Technologies (ORA). The Israeli operation, with a U.S. office in Reno, Nev., focuses on geothermal energy, using the earth's heat to generate electricity. "Every state is under a mandate to get a certain percentage of energy from a renewable power source," says Mahar, "and geothermal energy is 100 percent reliable, with no pollution. Ormat builds and operates geothermal plants and equipment, primarily in Western states, such as Nevada and California." The stock was recently trading at $36.21 a share, well up from its 52-week low of $22.08. It has a PE of about 30 and pays a small dividend of less than 1 percent.

Gene Walden lives in the Twin Cities and is the author of more than 20 books about business and investing. Send questions to gwalden100@comcast.net.