Tag: PBN

Petrobakken / Lightstream Resources bites the dust

Lightstream Resources (TSX: LTS), formerly known as Petrobakken (TSX: PBN), was formerly a subject of analysis on this website. Despite the company having excessively high yields and posting (and boasting) about huge cash flows through operations, I remained very skeptical of them. Then the oil price cratered at the end of 2014, and then all the excess leverage the company held came to bite it.

The senior unsecured creditors failed to reach an agreement with the company, and as a result they will be going into CCAA proceedings.

I have never held shares of this company. The entity, once restructured, should be mildly profitable in the current oil price environment, but they need to shed a healthy quantity of their debt. It is a classic case of using too much leverage when the times are good.

A few bargains – Oil and Gas

I’ve been examining the wreckage of the market carnage over the past few days (these types of high volatility situations tend to create opportunities) and in general I have not been too impressed with what I have seen. Either that, or what I have been examining has been unfruitful material.

The big exception: the oil and gas sector.

The reason why they have cratered is because of this chart:

wtic

Then I start scouring the list of TSX oil and gas sector companies that are over a market capitalization of a billion dollars. The TSX maintains a comprehensive list of listed companies which I find to be of surprising value when I look for quick lists of companies. I generally don’t tread below a billion in capitalization for resource firms since companies of that capitalization are dominated by insider information where a good drilling result will make the difference between life and death and the last person to get this information will be the outside public.

Larger capitalization companies also receive the benefit of financial economies of scale as they will be able to raise capital in meaningful amounts at lower costs – just imagine if you were a bank lending to a $10 million microcap exploration company versus lending to Suncor – a world of difference.

I also exclude anything international (e.g. CNOOC) as my comfort level with companies with international operations (outside Canada/USA) is quite low. There are some Canadian companies with international operations (e.g. Husky) but I have not excluded them from the list.

This leaves the following:

NameRoot
Ticker		 QMV(C$)
31-August-2014 		O/S Shares
31-August-2014 		Price Aug 31Price Oct 17Diff
Suncor Energy Inc.SU65,392,529,9631,465,214,653$44.63$37.43-16.1%
Canadian Natural Resources LimitedCNQ51,752,147,4691,092,047,847$47.39$38.64-18.5%
Imperial Oil LimitedIMO49,042,078,776847,599,011$57.86$51.56-10.9%
Husky Energy Inc.HSE32,835,380,634995,641,711$32.98$27.89-15.4%
Cenovus Energy IncCVE26,251,047,328756,950,615$34.68$26.44-23.8%
Crescent Point Energy Corp.CPG19,054,037,160423,423,048$45.00$37.80-16.0%
Encana CorporationECA18,575,904,053740,961,470$25.07$20.99-16.3%
Talisman Energy Inc.TLM11,519,723,5791,044,205,268$11.03$7.41-32.8%
Canadian Oil Sands LimitedCOS11,349,573,179484,610,298$23.42$17.97-23.3%
Tourmaline Oil Corp.TOU11,093,225,024201,438,624$55.07$46.15-16.2%
ARC Resources Ltd.ARX9,961,515,096316,942,892$31.43$28.70-8.7%
MEG Energy CorpMEG8,663,315,635223,684,886$38.73$29.03-25.0%
Baytex Energy Corp.BTE8,074,310,078166,069,726$48.62$36.10-25.8%
Vermilion Energy Inc.VET7,547,863,325106,713,747$70.73$64.36-9.0%
Paramount Resources Ltd.POU6,310,684,139104,654,795$60.30$51.77-14.1%
Peyto Exploration & Development Corp.PEY5,921,706,832153,690,808$38.53$34.20-11.2%
PrairieSky Royalty Ltd.PSK5,135,000,000130,000,000$39.50$34.00-13.9%
Enerplus CorporationERF5,108,169,000205,229,771$24.89$17.15-31.1%
Whitecap Resources Inc.WCP4,521,895,736245,621,713$18.41$14.98-18.6%
Penn West Petroleum Ltd.PWT4,182,765,734495,001,862$8.45$5.51-34.8%
Pengrowth Energy CorporationPGF3,938,186,665531,408,321$7.41$4.90-33.9%
Athabasca Oil CorporationATH3,181,210,140401,667,947$7.92$4.46-43.7%
Trilogy Energy CorpTET3,034,453,657105,071,110$28.88$20.80-28.0%
Bonavista Energy CorporationBNP2,991,583,651201,861,245$14.82$11.61-21.7%
Africa Oil Corp.AOI2,120,742,964312,333,279$6.79$4.14-39.0%
Bonterra Energy CorpBNE2,112,574,63332,086,492$65.84$53.82-18.3%
Gran Tierra Energy Inc.GTE2,003,447,146274,821,282$7.29$5.37-26.3%
Raging River Exploration Inc.RRX1,980,564,289180,051,299$11.00$8.14-26.0%
Birchcliff Energy Ltd.BIR1,969,417,138150,796,625$13.06$9.16-29.9%
Freehold Royalties Ltd.FRU1,925,524,14674,058,621$26.00$21.48-17.4%
Northern Blizzard Resources Inc.NBZ1,914,042,495101,810,771$18.80$15.85-15.7%
Surge Energy Inc.SGY1,889,478,484217,681,853$8.68$6.54-24.7%
Parex Resources IncPXT1,877,462,466126,287,061$14.87$10.73-27.8%
Kelt Exploration Ltd.KEL1,731,091,845126,727,075$13.66$10.55-22.8%
Bankers Petroleum Ltd.BNK1,721,811,689260,880,559$6.60$4.67-29.2%
Bellatrix Exploration LtdBXE1,611,292,542191,364,910$8.42$5.59-33.6%
NuVista Energy Ltd.NVA1,583,757,118135,944,817$11.65$10.05-13.7%
Legacy Oil + Gas IncLEG1,563,886,292199,730,050$7.83$5.06-35.4%
TORC Oil & Gas Ltd.TOG1,362,827,02893,344,317$14.60$11.29-22.7%
Painted Pony Petroleum Ltd.PPY1,362,274,68393,627,126$14.55$11.38-21.8%
Crew Energy Inc.CR1,359,860,601121,960,592$11.15$7.90-29.1%
Oryx Petroleum Corporation LimitedOXC1,296,506,662119,825,015$10.82$9.47-12.5%
Lightstream Resources Ltd.LTS1,257,107,698200,176,385$6.28$4.08-35.0%
Advantage Oil & Gas Ltd.AAV1,228,830,837170,651,966$7.20$5.10-29.2%
Long Run Exploration Ltd.LRE1,097,545,166194,204,965$5.65$3.58-36.7%
Spartan Energy Corp.SPE1,096,574,094262,338,300$4.18$3.22-23.0%
RMP Energy Inc.RMP1,068,310,163122,092,590$8.75$6.30-28.0%

A cursory look reveals that the quoted market price of all of these corporations are significantly less than what they were from August 31st, however, some got hammered more than others.

Whenever one invests in a resource company, there is always the implicit assumption that you believe the commodity price underlying the resource will rise. There is absolutely zero point in investing otherwise unless if there is a very special situation to warrant it (e.g. the firm in question has a huge hedged position on the resource that will allow it to economically outlast its soon-to-be bankrupt peer group).

Ideally you want to invest in a company with a cost structure that is at the marginal point of profitability and that has the market pricing the company assuming it will make little money in the future, and then have the commodity price increase. The embedded leverage in these high cost producers is significant – and I will keep on repeating this – under the assumption that the underlying commodity price increases.

Looking at the “least and most killed” list, we have two companies that I consider to be the cream of the crop in the Canadian oil and gas industry, ARC Resources (TSX: ARX) and Peyto Exploration (TSX: PEY) that are scratched – about 9 and 11% losses, not too bad considering the drop in commodity prices. These two companies have quite good managements and they are very focused on financial return on investment. I actually consider it too bad they did not get a 25 or 30% haircut as they are reasonably good “grandmother and grandfather” type equities that should be able to weather the full storm of a commodity cycle.

On the “ripped to shreds” list, we have Athabasca Oil Corp (TSX: ATH) that I will not touch because they simply have the incorrect economic structure (this can be saved for another post although you can read me correctly passing up on their IPO on this post).

Working the way down the losers list, a few names caught my attention. Lightstream Resources (TSX: LTS), formerly Petrobakken (TSX: PBN) is an entity that I will not be investing in, but I amusingly note that it is finally reaching what I would consider to be a fair value. There was a very dedicated individual out there that was deriding my analysis on its over-valuation which the market finally appeared to have corrected. (Feel free to read these articles here).

However, a couple old titans from the income trust era, Penn West (TSX: PWT) and Pengrowth (TSX: PGF) caught my attention. Penn West notably went through an accounting scandal when they changed top management and the subsequent audit resolved some issues pertaining to the capitalization of what should have been operating expenses. This involved the inflation of the net income line. Having the commodity oil market fall from underneath them did not help either. PWT made the unfortunate mistake of going to natural gas development at precisely the wrong time, but they hold a bunch of other more conventional oil assets which firmly put them in the ordinary category.

Notably they are trading at about a third of their stated book value. One would have to ask themselves if they were to start up that company from scratch how much would be paid to do so. Even when dumping goodwill and accumulated exploration assets (money already spent to do exploration work), there’s still about $4.9 billion in equity on the balance sheet while the market cap is around $2.7 billion today. Just from a fundamental value perspective, while previous investors got hosed, it may be a better entry point than not. The stock is likely to face tax loss selling pressure between now and the rest of the year so there’s not likely any rush to get in on a retail level.

Pengrowth is also going through an ambitious capital plan with the development of a heavy oil resource (their “Lindbergh” project) that apparently has good economics, along the lines of a Cenovus project. There is obvious execution risk with this project as many oil and gas companies have touted the promise of heavy oil while being able to produce nothing. The couple differences I see here is that Pengrowth has been in the game long enough (they’ve been public since 1989) that they should by now know what they’re doing, and also they’ve successfully executed on a pilot project that has dredged up a not trivial amount of oil from the ground already. Time will tell.

Dumping goodwill and exploration assets from PGF’s balance sheet leaves $2.4 billion in book value, while market value is about $2.6 billion presently. On its face it does not appear to be as good a value as PWT, but it appears relatively cheap from a valuation perspective.

Notably, Penn West’s equity is trading with incredibly high implied volatility – about 85% on the January series for an at-the-money option. Pengrowth’s volatility is muted (around 35%). Liquidity in their option markets is garbage, plus trading options on Canadian exchanges is a very expensive process in terms of trading costs.

Both firms give out dividends and are roughly at 10% yield at present market value. Yields might be compromised in the future if oil prices continue to decline. At least investors here clearly are not paying any premium for yield since I think most of them have been scared away from the common stock when they stare at their capital losses – a few months ago they were paying for a 5% yield and while they received that, they got a 50% capital loss in exchange.

The last time oil was at around US$80/barrel was in June 2012. Both companies’ equities were trading at significantly higher levels than they are now, plus they have the advantage of the Canadian dollar being about 10 cents lower than what it was a couple years ago.

Do I have any clue where oil is going in the future? No. However, if you believe things have stabilized, certain oil and gas producer stocks seem to have been sold off disproportionately and would probably make a decent entry point.

Petrobakken / Lightstream

It has been some time since I’ve written about Petrobakken (prior slew of articles here), now renamed Lightstream Resources (TSX: LTS).

Pretty much the trajectory to its share price was what I was more or less expecting, simply because investors would come to the realization that capital expenditures are indeed expenses that are incurred today, as opposed to over some mythical amortization curve:

lts.to

A few weeks ago the company announced its targeted production rates, but finally started introducing language concerning the leveling off of its production. The language used in the release was quite creative:

As our resource play assets mature and our base decline rates gradually reduce, we continue to work towards levelling out our production profile and increasing our annual average production levels on a year over year basis. As we enter the fourth quarter, we are on target to exceed the lower end of our forecasted 8% to 12% annual average production growth (46,000 to 48,000 boepd) and we continue to target exit production in excess of 47,000 boepd. By addressing facility challenges and executing the remaining components of our 2013 capital program, we believe these achievements will be met within our capital budget of $700 to $725 million.

We are currently finalizing our operational and financial plans for next year and remain committed to improving our sustainability ratio (cash outflows compared to cash inflows), lowering our debt to cash flow ratio and improving our liquidity through the many options available to us, which include, but are not limited to, modulating capital expenditures, selling assets, terming-out debt, altering our dividend program or issuing equity. Over the long-term, we continue to target a sustainability ratio of 100% and a debt to cash flow ratio of 2.0 or less. We plan to announce further details with respect to these options when we release our 2014 guidance later in the fourth quarter of 2013.

I love the use of the word “modulating” instead of what it really is – a reduction. Once the production curve is levelled, the financial game is finally over – there is a very clear indication how much money is required to maintain stable production. And investors figured out some time ago that it is quite expensive to do so for what they are purchasing.

So when we look at the debt side of the balance sheet, both the banks and the bondholders are wondering how they’re getting their $2.1 billion back. The bondholders have to wait until 2020, but the banks will extract their pound of flesh in 2016 unless if the company gets serious in reducing its cash burn profile.

There is only one way this is going to occur – a reduction in dividends. They tried doing this stealthily by introducing a stock component to the dividend, but this will only further increase the erosion of the value of equity holders in the company. The lion’s share of cash will be going to debtholders in the future. That said, there is some value in the equity, but just not what it is currently trading for.

Market musing while being inactive

I hate to sound like a broken record, but I’ve still been doing nothing other than research but nothing worth investing in at the moment except for one illiquid play mentioned in an earlier post.

Here is a series of miscellaneous observations:

* I note that Apple (AAPL) continues its slide down to the point where I am wondering if they are pricing that the company is not going to be able to keep its premium pricing strategy. On paper, they are still massively profitable, but if competition continues to chip away at their product line (mainly through Samsung on the phone front and a variety of other realistic competitors on the tablet front), they might run into revenue growth problems. The company in their last fiscal year (ended September 2012) made $156.5 billion in revenues and this year the analysts are projecting an average of $182.8, which is a $26.3 billion increase year-to-year. This is a huge amount of growth and the law of large numbers will likely be catching up to Apple in short order.

* CP Rail (CP.TO) is trading at absurdly high valuations at present. They performed a change in management and the market is giving the new CEO a lot of credit, but the railroad business is very mature and I don’t have a clue why they are giving the equity such a huge premium at the moment. I’d be a seller at this price range (the C$130 mark).

* Anybody remember the big scare about rare earths a couple years ago when China started restricting the supply and most of those stocks went crazy? The big play here, Molycorp (MCP) has continued to slide into the gutter now that the market reality of the perceived shortage has completely gone away. The substitution effect is very powerful and MCP shareholders are holding the bag.

* Likewise, most other fossil fuel commodity companies, including my favourite company that has been so overrated by many, Petrobakken (PBN), are continuing to suffer. It is similar to how most gold mining companies are not faring nearly as well as the underlying commodity – it costs an increasing amount of money to extract the resource, so even if the commodity price is increasing, if your costs are increasing, you are not going to make much money. Even Crescent Point Energy (CPG.TO) is starting to lose its lustre.

* The other commodity market that is continuing to get my curiousity up is currency trading – the US dollar has continued to outperform most of the other global currencies. The only way that I play this is that I try to hedge my portfolio by having some US-denominated securities rather than using leveraged speculation.

* The two Canadian Real Estate financing proxies, Home Capital (HCG.TO) and Equitable Group (ETC.TO) warrant a further look. HCG has faded somewhat off of its 52-week high, but Equitable is still there. If people are still hyper-bearish on the Canadian real estate market, these two companies should be the first on anybody’s short selling list. Non-performing loans are still around the 0.3% level and currently still do not show any real signs of distress in the market. I am still riding the wave on Genworth MI (MIC.TO) and believe there is still a reasonable percentage gain to be realized from current price levels. The loan companies, however, are hugely leveraged and I’m finding it difficult to see value there when book values are so significantly below market prices.

* Long term interest rates have also taken a nose dive – the Canadian 10-year bond was skirting at the 2% yield a month ago, but now they are back down to 1.8%. The world is awash with capital and there are few places to deploy it where you’ll generate yield at an acceptable risk level. Eventually the leverage party will end and the fallout is going to be very brutal. Whether this happens in 2013, 2014 or later, nobody knows. But there will be fallout, and figuring out how to brace yourself for the fallout will be a big financial challenge over the next decade.