Taking a full swing

One of the attributes that first attracted us to oil and gas heavyweight, XTO Energy (NYSE: XTO), was the company's skill in expanding resources from existing assets. Therefore, we are extremely excited to see management make their largest acquisition to date - a move likely to underpin strong future growth.

On the charts, buoyant investor support saw the stock extend the long-term upward trend to a new all-time high of $62.25 during the past week. This represents a rally of more than 17 percent since February's initial buy recommendation.

As we discussed in FAT54, over time the company has engineered phenomenal success through acquiring producing oil and gas assets at a relatively low cost. Following each acquisition, the expert team of geoscientists set about increasing reserves and production.

Looking to do the same with a new set of assets, management recently announced that it had purchased a portfolio of oil and gas properties from Dominion Resources for $2.5 billion.

To place the magnitude of this deal in context, XTO's management had originally budgeted $1 billion for acquisitions this year. However, the new assets complement the existing portfolio well, delivering enormous growth potential for the company. In the words of CEO Bob Simpson: "this is the one you take the full swing on".

The majority of the new assets are located in the Rocky Mountains, stretching from New Mexico to Northern Montana. The assets in this region will add 810 billion cubic feet of natural gas equivalents to reserves and 126 million cubic feet to daily production.

The remaining properties are located in South Texas and include 250 billion cubic feet of gas equivalent reserves, with 74 million cubic feet of daily production.

Following the deal, the company's proved reserve base now stands at 9.6 trillion cubic feet of gas equivalent. Consequently, management expect production growth of 15 percent on last year, to 1,760 million cubic feet per day. Of this, 65 percent is hedged at an average of $9.83 per thousand cubic foot - comfortably above current prices.

Management appear to have negotiated a favourable deal in regards to the price paid (around $2.36 per thousand cubic foot). Especially if one considers that, based on past experience, XTO's team will likely expand the properties' resource base and production in the years ahead.

In order to finance the acquisition, XTO plans to raise around $1 billion through the issuance of 15 million new shares at a price of $60.50 each. The offer is expected to settle and close on Monday June 11, with the remaining $1.5 billion financed through debt.

But with the stock price currently below the offer price and well above our initial entry price, we do not recommend investing additional capital at this stage.

Returning to the charts, any stock would be at risk of pausing for consolidation following such rapid appreciation. However, with upward momentum remaining firm, we believe downside risks are limited. Initial support lies at $56.75 with the May low of $54.10 underpinning near term upward momentum.

And despite the recent stock price gains, XTO trades on an undemanding 2008 price-to-earnings ratio of 13.5 times.

In brief, the latest acquisition allows XTO to continue with the strategy that has served shareholders so well over the years. Moreover, the company's large resource base offers excellent exposure to our bullish view of future energy prices. Thus, XTO Energy will remain firmly held in the Fat Prophets Portfolio.