Category: Equity

Petrobank / Petrobakken – How to play Petrobank

I noticed that one of the most bullish people on Petrobank (TSX: PBG) / Petrobakken (TSX: PBN) that I know of on the internet has stated they have “Caved to a moment of weakness” and increased the concentration of their PBG holdings to 40% of their equity portfolio. This is as close as you can get in finance to an “all-in” bet without actually going all-in.

I wrote about portfolio concentration in a previous post, and if your portfolio size is a sufficiently small fraction of your annual income, then making concentrated bets is not only acceptable, but ideal.

PBG owns 59% of PBN, so PBG is joined at the hip with PBN’s performance. Indeed, looking at the consolidated financial statements of PBG is quite challenging since one has to mentally sort out what PBN is doing away from the main figures and this takes a bit of work. They do some segmenting in the management discussion and analysis, but the relevant component is that PBG’s business unit does not make any revenues and spent about $54M in Q1 for capital expenditures. Also, when subtracting the market capitalization of PBG’s ownership in PBN, PBG’s price is around $40M. If you believe PBG’s operations have any value at all, it would make PBG the better bet between the two companies.

A very relevant issue for PBG is that they depend on PBN’s dividend stream to provide approximately $100M/year of cash. PBN’s dividend level is at a point where I would expect it to be dropped at some point in the future. PBG also has a mostly untapped $200M line of credit at its disposal and it has the option to selling more of its PBN stake, although I am sure management would not want to press down PBN further from current levels.

A believer in PBG’s operations (but not PBN) would likely be better served by going long PBG and shorting PBN. Calculating the ratio is an exercise in arithmetic: an investor purchasing 100 shares of PBG can offset the PBN ownership by shorting 104 shares of PBN.

Encana – PetroChina deal fallout not that bad

I notice natural gas titan Encana (TSX: ECA) traded a bit lower after they announced that their previously announced joint venture with PetroChina for a shale gas field fell through.

I do not view this as being too adverse an event – Encana’s management has typically been quite long-range viewing and they are dealing with a very difficult situation in the natural gas market, with spot prices currently CAD$4.30ish and typical marginal costs of extraction higher than this. They have frequently stated that they believe the natural gas marketplace is artificially low and the best thing for resource companies with plenty of reserves on the ground is to wait for higher commodity prices before drilling. My guess is that PetroChina’s management had more of a short term focus.

Back in fiscal 2008, spot natural gas went well above $10 and Encana had a banner year on earnings, reporting over $8/share (note the 2008 number is not a direct comparison with the present company because the company split off Cenovus in 2009 which also benefited from $150 crude oil). If we ever see higher natural gas prices, Encana should be well positioned to capitalize. Currently with shale gas drilling there is a huge supply glut in the marketplace.

In 2010 the company earned $2/share on an average spot natural gas price of about $4.25 per mmBtu. Encana at present values appears to be a fairly good “grandmother” type stock that should retain its value even in adverse market conditions. Even in the depths of the 2009 economic crisis (which is generally what I use to gauge maximum downside) the stock did not trade lower than 20% below existing market values.

It is an interesting comparison to look at a company like Microsoft and ask oneself whether it is likely in the medium range future whether licenses for Windows and Office will be more or less valuable a commodity than natural gas.

Petrobakken – Bank Debt – Due 2012?

Investors in Petrobakken (TSX: PBN) are continuing to discover why yield is not something that should be chased lightly – although they are probably looking at their 6.7% current yield on the $14.27 share price are feeling smug, the approximate 36% depreciation in share price over the past year is something they likely would have not wanted in conjunction.

The latest news out of Petrobakken is something they didn’t announce. Specifically, the following comes from their last quarterly financial release (for the 3 months ended March 31, 2011):

Note 9 – Bank Debt
The Company maintains a covenant based revolving credit facility with a syndicate of banks. The facility’s lending amount has a borrowing capacity of $1.2 billion. The current term for the facility ends June 3, 2011 and can be extended by the lenders for an additional year. If the lenders were not to extend the term, the drawn amount would become due on June 3, 2012. The credit facility bears interest at the prime rate plus a margin based on a sliding scale ratio of PetroBakken’s debt to earnings before interest, depletion, depreciation and amortization (“EBITDA”). The facility is secured by a $2.0 billion demand debenture and a securities pledge of Company’s assets.

June 3 has come and is nearly three weeks past. No extension of the credit facility has been announced so it is probable that the $966 million in bank debt (which will be higher for the second quarter financial release) will be called on June 2012. So this means that the clock has started for PBN to shop around for a billion dollars of financing – will they sell more debt? Or will they give the banks some more interest?

In terms of the rate that is being charged by the banks for the facility:

The applicable margin charged by the bank is based on a sliding scale ratio of PetroBakken’s debt to earnings before interest, taxes, depletion, depreciation and amortization (“EBITDA”). The facility is secured by a $2.0 billion demand debenture and a securities pledge on the Company’s assets. The credit facility has financial covenants that limit the ratio of secured debt to EBITDA to 3:1, limit the ratio of total debt (total debt defined as facility debt plus the value of outstanding debentures in Canadian dollars) to EBITDA to 4:1, and limit secured debt to 50% of total liabilities plus total equity. The Company is in compliance with all of these covenants.

I couldn’t find explicitly what the rates were from the financial statements, but doing some arithmetic on the 2010 annual financial statements and subtracting the interest they paid from their US$750M convertible debenture issue, I believe Petrobakken paid prime (3%) for their bank debt in 2010.

You can be sure that the banks want something more than prime for this round of financing – if the renewed credit facility charges prime plus 100bps, this will be another $10M/year in pre-tax cash that will be going out the window for PBN shareholders as the cheap financing dries up.

Petrobakken continues to remain on my radar, but as I stated in my “value trap” article, even at present valuations I will not be touching it. My guess continues to be that we will see a dividend cut or even floating a very unattractive (for them) equity financing in conjunction with a renewal of the credit facility. PBN still has a market capitalization of $2.6 billion and they could sell off 10-15% of the company and raise roughly $250-$500M which would reduce the debt-to-equity and keep their costs of borrowing at prime-like rates.

Markets in a brief rally mode

As much as I despise technical analysis, the following short-term pattern on the S&P 500 chart came to mind and is probably on the minds of technical traders out there:

It would suggest that we would see another couple percent of gain in the S&P 500 before this stalls out (to around the 1310-1320 level).

It is my opinion that we continue to be in a range-bound market and that index investors are not going to be making money on their investments. In order to seek outsized returns, you must be able to look at smaller cap companies, but these come with larger risks.

The dangers of technology investing

Shareholders of Research in Motion (TSX: RIM) are likely feeling a lot lighter in the pocket from three months ago. I don’t have any comments on the valuation of the company other than that the market weights future performance than past performance – RIM over the past reported about $6/share in earnings and when combined with their $27 share price makes the company look like a spectacular value. Even when looking at the analyst estimates, most are projecting they will make $6/share for the next couple years.

The truth, however, is not so simple – the company is facing intense competition through a couple channels – Apple with their iPhone/iPad and Google’s Android operating system embedded on a myriad of devices that are chipping away at Blackberry. As shareholders of Nokia (NYSE: NOK) might know, when you give up a lead in technology, it may be permanent or at least very long.

In the “social networking” domain, Friendster was trumped by Myspace, and now Myspace has been trounced by Facebook. Predicting the evolution of technology is not easy.

In the “search” domain (i.e. online advertising), Google so far is the winner, with old players such as Lycos, Excite, Infoseek, Altavista and Yahoo left behind.

Microsoft, for the most part, appears relatively insulated from the change in technological trends, mainly due to people’s acclimatization to the Windows and Office suites. Linux’s various permutations has failed to permeate into the client marketplace to a significant degree while OpenOffice and its derivation (including Google Docs) has not penetrated Microsoft Office to any extent. However, a bet on Microsoft relies on the fact that these two core assumptions are true. While Microsoft does have a financially viable video game division, this is not the primary bet a Microsoft shareholder implicitly makes – rather, it is that they are able to maintain monopoly-level pricing on Windows and Office.

Apple shareholders also received adverse treatment from Microsoft back in the 1990’s and nearly faded into oblivion until they revamped their product marketing with the iMac. The question of 2012 is: Will Apple or Google shareholders receive the same treatment from some other upstart company?

Finally, with RIM, if you anticipate that people will be using Blackberries (or other RIM devices) in the future, RIM might be a good bet. Investors with clairvoyant abilities to predict future technological trends will be handsomely rewarded with either gains, or the ability to sell out of a stock before the rest of the market realizes that the technology trend has changed.