Canadian oil patch for sale!

[Cardboard]

Investor sentiment towards Canadian oil & gas producers is certainly negative with the continued delay by Obama to approve the Keystone XL pipeline and fears of decrease in global oil demand. The recent flooding in Alberta is also not helping.

 

On Keystone XL, I think it is just a matter of time for Canadians to develop western and even eastern oil pipelines to ship their oil globally. Once that happens, it will trade closer to Brent prices removing forever a key competitive advantage that the U.S. has currently or access to land-locked oil priced at WTI. I think it is also worth mentioning that Canada is a geopolitically stable country!

 

The other piece that people are missing is that light oil produced in Canada is currently priced slightly above WTI. One of the reasons is that Canada produces a lot more heavy oil than it used to mainly due to the oil sands. This heavy "stuff" is called Western Canadian Select or WCS. In order to be processed into refined products it takes more complex refineries and upgraders. Of course, these things are very expensive and take a long time to build. Another alternative that heavy oil producers have found is to blend their product with light oil to reduce refining costs and to make it refineable without upgraders.

 

I think that is where lies the opportunity currently or Canadian light oil producers. Many of them trade at half of book value and well below tangible book. They also trade well below their NAV and at a price to cash flow below 3 times. They have 10 to 15 years of reserve and growing is simply adding more wells in well known areas. There has been as well very interesting insider buying recently. Debts are quite manageable and these guys could survive a crash in oil and remain cash flow positive while their counterparts involved in natural gas, heavy oil and the oil sands would be facing financial distress. So I think that there is a certain floor for oil prices due to production and finding costs that have gone up a lot in the past decade while demand still appears strong looking at close to $100 oil despite all the talk about a slowdown and a so called "glut" due to new U.S. production from fracking.

 

Some that I am studying currently: ARN, LTS, LEG, LRE, PWT and SGY.   

 

Cardboard

[alertmeipp]

I think that's the light oil producer thread Cardboard was mentioning about.

 

I recently bought into PWE.

[Guest Dazel]

 

 

We owned Novus Energy and we were  bought out recently by a company in China...there is still 5% left when the deal closes for cash...and there is a good chance they will get another offer from a north American firm it was not a big premium to assets... We took the appreciation and sold out.

 

 

Dazel.

[no_free_lunch]

Novus was interesting in that after the deal was officially announce and trading resumed, you could still buy the stock at over a 10% discount to the takeout price.  I sat there watching it, thinking I must be missing something but sure enough the gap has been closing.

[kevin4u2]

The only one that is cheap is LTS.  It also happens to the be the crappiest company on your list.  I would short SGY and possibly LEG. 

[plato1976]

PWE below tangible book is not cheap ?

 

The only one that is cheap is LTS.  It also happens to the be the crappiest company on your list.  I would short SGY and possibly LEG.

[alertmeipp]

PWE below tangible book is not cheap ?

 

The only one that is cheap is LTS.  It also happens to the be the crappiest company on your list.  I would short SGY and possibly LEG.

 

It has been cheap for years on price to book basis and the old management had not been executing well.

I bought back in mainly because of the new team which is focus on ROE.

[Myth465]

I own PWE and LTS. LTS you get paid to wait and wont be taken under its current price. PWE has a new team, new focus, which works as a great catalyst.

I dont like the small players, they are being taken under on the cheap by foreign companies.

[plato1976]

I think LTS is just the old petraBakken (not sure if I spelled correctly)

At its current price the div yield is a staggering 13%

Not sure how sustainable it is

Also no idea why it cannot be taken under its current price.

This one used to catch lots of discussion on seekingalpha (most posts from the ID "canadian value investor", who seems familiar with the oil&gas industry)

 

I own PWE and LTS. LTS you get paid to wait and wont be taken under its current price. PWE has a new team, new focus, which works as a great catalyst.

I dont like the small players, they are being taken under on the cheap by foreign companies.

[muscleman]

ARN: How come its company websites only have info up to 2011? That is weird.

[kevin4u2]

No. Tangible book is meaningless in analyzing these assets. A company can spend a lot of money on drilling wells that are sub economic. There assets are tangible but not worth the cost.

 

Thinking like an owner, if you bought all of PWE, you would earn roughly 8% before tax on your capital. That doesn't come close to the hurdle rate I use. LTS is 15%.

 

 

PWE below tangible book is not cheap ?

 

The only one that is cheap is LTS.  It also happens to the be the crappiest company on your list.  I would short SGY and possibly LEG.

[plato1976]

All right, I guess the question boils down to whether the low earning power of PWE is due to the nature of assets, or due to mis-management in the past; if it's the later case, we may count on the new management team to improve...

 

No. Tangible book is meaningless in analyzing these assets. A company can spend a lot of money on drilling wells that are sub economic. There assets are tangible but not worth the cost.

 

Thinking like an owner, if you bought all of PWE, you would earn roughly 8% before tax on your capital. That doesn't come close to the hurdle rate I use. LTS is 15%.

 

 

PWE below tangible book is not cheap ?

 

The only one that is cheap is LTS.  It also happens to the be the crappiest company on your list.  I would short SGY and possibly LEG.

[tengen]

Concerning Penn West (PWT up here in the GWN), I agree it's more of a "turn-around story" than a "value story". Rick George became the chairman back in June. Mr. George is a famous name in the Alberta oil-patch. He was the CEO of Suncor for 20 years and he is considered by some to be the "father of the oil sands sector". You can read some stuff about him here:

 

http://business.financialpost.com/2011/12/01/an-oil-sands-visionary-departs/

 

Of particular interest to those hoping he brings the same success to Penn West:

 

Mr. George joined Suncor Energy Inc. on Jan. 1, 1991, when the oil sands business was an experiment, the company was one of the world’s highest cost producers, its chief executive was dying of cancer, and its plant in Fort McMurray had suffered a devastating fire and a 5 ½ month labour dispute.

 

Yet under his leadership, Suncor, the first company to invest in the oil sands half a century ago, pushed many of the innovations that made Alberta’s deposits what they are today: the world’s third largest oil resource, a magnet of energy investment, the engine of Canada’s economy. Meanwhile, Suncor’s market value grew to $50-billion, from $1-billion in 2001, as it took bold steps like launching its Millennium expansion when oil prices had sunk below $10 and purchasing Petro-Canada for $19.2-billion in the depth of the 2009 global recession.

 

Disclaimer: I own some.

[ThanksAndYouAreWelcome]

How do you think PWT is going to turn-around the story? The reason I ask is that I have a hard time believing they can fix the leverage issues in this market, and with them trading as high as they are, even if they can sell assets I don't see how the valuation compensates an investor for the risk. Any color is appreciated.

[alertmeipp]

How do you think PWT is going to turn-around the story? The reason I ask is that I have a hard time believing they can fix the leverage issues in this market, and with them trading as high as they are, even if they can sell assets I don't see how the valuation compensates an investor for the risk. Any color is appreciated.

 

Not sure how, but it will be a combination of cost cutting, asset sale, smarter spending on capital, better WTI and differential pricing.

 

 

[tengen]

Yes, it's cost cutting. PWT is seen as one of the less efficient operators. The hope is that Mr. George can work some of the same magic he produced for Suncor (who once upon a time had similar issues).

[plato1976]

This is what I was saying: if their assets are not intrinsically inferior, its earning power can be fixed

 

Yes, it's cost cutting. PWT is seen as one of the less efficient operators. The hope is that Mr. George can work some of the same magic he produced for Suncor (who once upon a time had similar issues).

[Cardboard]

As a reminder to some of the responses, my post was made on June 26. Since then the "study" list has performed as follows:

 

ARN up 45%

LTS down 10%

LEG up 30%

LRE up 47%

PWT up 4%

SGY up 17%

 

So some are no longer as attractive as they were.

 

ARN is very speculative since it is a land play on Swan Hills which is a new development area. CPG and LTS both own slightly under 20% each of the company.

 

LTS is highly mismanaged IMO with Wright keeping debt and the dividend too high and showing little drive to cut cost and apply capital spending restraint. I also suspect a conflict of interest since the high dividend allows Petrobank to survive and keep alive the "dream" or Thai process.

 

LEG is phenomenal with great management and some of the highest netbacks in the industry. A good comparison is WCP which trades at a much higher multiple most likely because it pays a dividend. Still trades at 3.7 times cash flow despite a good run.

 

LRE is still trading at 2.8 times cash flow despite the large price appreciation. Their focus towards light oil in the last 18 months has really paid off.

 

PWT is a turnaround story. Price to cash flow at 5.1 times is not that attractive but, they are working hard to change the culture there: reducing costs and focusing on highest return capex. Disposition of assets should bring debt down such as the Duvernay play. The new CEO from Marathon seems very good to me. He really wants employees to think that they are a small nimble firm. He is right since PWT may be big in Calgary but, tiny in the oil & gas world. They have a very good asset base. With the right focus and under a low cost regime, this company will surprise many in terms of profitability.   

 

SGY trades close to 4 times cash flow. This one was interesting to me because of Paul Colborne who is a director and also at LEG and who appears to be a savvy oil & gas investor. It also started to appreciate before all the other ones or from 2 times cash flow so I wanted to see what had happened to make investors take notice.

 

Another addition to my list is NGL. This company is essentially for sale and trades at 2.5 times cash flow. This company has also moved heavily towards light oil from natural gas over the past 18 months and netbacks are increasing very nicely. The best part is that it owns the 5th largest land position in the Cardium. This area is just north west of Calgary and has been put back to life with directional drilling and fracking. So it has all the infrastructure needed (electricity, pipelines, refineries) and it is 70% light oil (including natural gas liquids).

 

Cardboard 

[ThanksAndYouAreWelcome]

On Penn West again, I don’t disagree that they will be able to make themselves better, I just don’t get how this ultimate creates value for an investor at the current share price. For example, if I take the optimistic end of their guidance for 2013 ($35,000/boepd and 20% decline), they need to spend ~$980 million to just hold production flat at ~140,000 boepd. Add on over $270 million per year they need to pay in dividends (including the DRIP), and that means they need ~$24.50 per boe cash flow netbacks to just hold production flat and pay the dividend without having to add on debt! Last quarter they had cash netbacks of $21.80 per boe when Edmonton light oil was over $90 CAD per bbl! I look at how steep the curve goes down in the future for oil prices, I look at how their decline rate will likely go up as they drill more in the Cardium, I see the risk they’ll have to cut the dividend again if they sell cash flowing assets, I see little chance for them to sell assets at values higher than what the share price would suggest they’re worth, and then I see net debt three times larger than cash flow and an EBITDA multiple of seven times! Yeah they will be able to sell some assets and make things better operationally, but I don’t know how the turnaround investment makes sense from a value perspective? What is a fair value range for Penn West? I think the oil patch is on sale right now but don’t get why someone would pick Penn West relative to a TORC or Whitecap for example? It makes me wonder what people are seeing in Penn West’s valuation I am not…

[Cardboard]

Well, let's make a comparison with WCP.

 

First of all, WCP is much smaller than PWT and is considered an intermediate producer vs a senior producer. Unless we are in a raging bull market for oil & gas stocks, smaller companies always trade at a discount. This is due to them being less diversified and too small for funds. So yes, WCP looks no more expensive than PWT and maybe cheaper on a profitability standpoint but, my second point will show that they are about as good as they will get. With NAV estimates in the $18-19 range, PWT trades at a very significant discount vs what you will find with other companies of similar size.

 

When one compares how profitable WCP is vs PWT on a cash flow/boe basis or around $38 vs $21 and then looks at the proportion of liquids produced: 71% vs 65%, then it becomes clear how mismanaged PWT has been for years. It is not that they are producing too much natural gas (this will be improved nonetheless), but that they are fat and have allocated capital to fields not profitable enough. The goal now is to spend 90% of capex towards light oil and on best ideas. There is no reason why PWT should not have a cash flow/boe closer to $30 considering their assets. Size should also be an advantage and not the opposite.

 

So the entire proposition is about making the company smaller, changing the culture and capitalizing on what they own already. What they will be able to sell and at what price will also make a big difference on the debt ratio which is a big concern for investors at the moment. Mr. Roberts has the experience and will to get this done and has full support from the board which includes Rick George as mentioned.

 

I would also not forget that Allan Markin was on the board for a few months and bought a very significant stake in the company with his own money or well over $10 million. These are two stars from the Canadian oil patch, both officers of the Order of Canada and who know how to manage properly an oil & gas company. Mr. Markin also visited most if not all PWT properties and made many suggestions on how to improve things. His cost cutting mantra and vision is perfectly in line with the one of Mr. Roberts. His departure looked bizarre but, it could be linked to his past involvement with CNQ which could be an interested player in some PWT assets or all of it.

 

Cardboard 

[Myth465]

Yes basically PWE is an asset play.

I think they will sell the Duvernay, which has no production. A decent price could fix the balance sheet. I also like the cost cutting I have been hearing about on presentations, and the completion of the strategic review for Q3.

 

http://www.bloomberg.com/news/2013-06-11/penn-west-breakup-seen-returning-3-7-billion-real-m-a.html

 

I think People are a bit hard on Lightstream, they way they explain their business makes sense. I also believe they separated from Petrobank so dividends dont go to Petrobank to fund Thai. They will have to do something though, the business is just too cheap and shareholders are just about done. My cost basis is 7% higher or so, but many are sitting on 50% losses.

[Cardboard]

"The Company’s investments in marketable securities consist of Lightstream common shares (TSX) and

U.S. dollar denominated 8.625 percent senior notes."

 

Interest and dividends received from Lightstream are Petrobank's only source of income.

 

Cardboard

[Myth465]

"The Company’s investments in marketable securities consist of Lightstream common shares (TSX) and

U.S. dollar denominated 8.625 percent senior notes."

 

Interest and dividends received from Lightstream are Petrobank's only source of income.

 

Cardboard

 

Thats interesting, I stopped following Petrobank after the spinoff.

http://www.timescolonist.com/business/petrobank-spinoff-of-petrobakken-stake-completed-1.38451

 

So basically they spinout Petrobakken which was the source of cash for Petrobank, then use $40 million to buy a mix of Petrobakken and notes yielding 8%.

 

---

 

At June 30, 2013, Petrobank had cash and cash equivalents of $30.6 million, investments in marketable securities of $44.7 million and a net working capital surplus (including cash and marketable securities) of $71.0 million. Our focus in 2013 is to steward our capital to maintain financial flexibility to pursue future projects and acquisition opportunities while positioning the company to benefit from our strong capital base. We expect to fund our 2013 expenditures with cash on hand and sales revenue from production.

 

----

 

Previsously when Petrobakken was significantly owned by Petrobank it literally funded the operations of Petrobank. Now he has just put a portion of his cash in high yielding securities and has chosen Petrobakken. A bit convoluted, but post spinoff. I dont think its fair to say the high dividend yield is mainly to fund Petrobank. Petrobakken needs to fix up its capex / debt situation, but I agree with Wright, cutting the dividend wont really help much given how small it is relative to cash flow after the drip. It looks like they plan on waiting for higher oil prices, or selling assets.

[moustachio]

WRES is another small cap oil company that trades real cheap on a cash flow and assets basis. It isn't a Canadian company, though. It has a relatively new CEO and is worth checking out. I'm long.

[ThanksAndYouAreWelcome]

I hear these points and think they are good. I just have to ask you a couple more questions if I can? Not as important, but I didn't think that there is a relationship between size and valuation over around $1.5 billion? Otherwise why does WCP and BNE trade at a premium to CPG? Or SGY trade higher than LTS? Also, if diversification is bad, why does KEL trade so high a valuation? Why has RMP done so well? And why did CPG do so good for so long?

 

On PWT valuation, I'm curious how you get to a ~$18-19 NAV valuation, that would mean you think they should trade at ~10x EBITDA, or above every single other oil guy in the whole Canadian oil and gas company?

 

I like your point on increasing the netback, but don't you think that is partially due to the nature of the asset base on not just how they've spent money? They might be able to increase the netback to $30, but I wonder what happens to the decline rate if they do so, and if you run the math, that assuming they can achieve efficiencies at a strong oil price it still means they would have to spend a whole lot more money than what they are making... you basically have to ignore the debt.

 

I do agree size can be an advantage, that could work out for them. I also agree the team there looks to be really good... I am however scared this is a situation where a management team with a reputation for brilliance tackles a business with a reputation for poor economics...

 

I hope you guys are right, but I just think there are 1 foot bars to step over in this space and this one looks like a high jump.

 

Let's cross our fingers they can sell the Duvernay and oil stays above $100!

 

 

Well, let's make a comparison with WCP.

 

First of all, WCP is much smaller than PWT and is considered an intermediate producer vs a senior producer. Unless we are in a raging bull market for oil & gas stocks, smaller companies always trade at a discount. This is due to them being less diversified and too small for funds. So yes, WCP looks no more expensive than PWT and maybe cheaper on a profitability standpoint but, my second point will show that they are about as good as they will get. With NAV estimates in the $18-19 range, PWT trades at a very significant discount vs what you will find with other companies of similar size.

 

When one compares how profitable WCP is vs PWT on a cash flow/boe basis or around $38 vs $21 and then looks at the proportion of liquids produced: 71% vs 65%, then it becomes clear how mismanaged PWT has been for years. It is not that they are producing too much natural gas (this will be improved nonetheless), but that they are fat and have allocated capital to fields not profitable enough. The goal now is to spend 90% of capex towards light oil and on best ideas. There is no reason why PWT should not have a cash flow/boe closer to $30 considering their assets. Size should also be an advantage and not the opposite.

 

So the entire proposition is about making the company smaller, changing the culture and capitalizing on what they own already. What they will be able to sell and at what price will also make a big difference on the debt ratio which is a big concern for investors at the moment. Mr. Roberts has the experience and will to get this done and has full support from the board which includes Rick George as mentioned.

 

I would also not forget that Allan Markin was on the board for a few months and bought a very significant stake in the company with his own money or well over $10 million. These are two stars from the Canadian oil patch, both officers of the Order of Canada and who know how to manage properly an oil & gas company. Mr. Markin also visited most if not all PWT properties and made many suggestions on how to improve things. His cost cutting mantra and vision is perfectly in line with the one of Mr. Roberts. His departure looked bizarre but, it could be linked to his past involvement with CNQ which could be an interested player in some PWT assets or all of it.

 

Cardboard