The appeal of an emerging energy stock
This Canadian analyst looks at the price of oil and small energy stocks and chooses one that is promising but hasn’t started to move yet.
Buy low, sell high.
Easy to say, hard to do. Let’s face it, most investors buy only when a stock is already well on its way up the charts.
So let’s look at the case of a stock that hasn’t moved up yet.
It’s a stock that’s in a pretty risky business — oil and gas. And it’s a small stock into the bargain.
We’ll study it from the perspective of a VP and portfolio manager in Calgary who has an intimate view of the oil patch.
Ms. Joanne Hruska tells the story of this emerging energy stock in Investor's Digest of Canada. A good deal of thought must go into the purchase of any stock, but especially a small one.
And Ms. Hruska gives us a step-by-step view of the decision to buy Twin Butte Energy (TSX-TBE), a junior oil and gas producer.
An excellent valuation
As the New Year began, this portfolio manager and her colleagues were engaged in the popular boardroom game of “forecasts, forecasts and more forecasts.”
We’ve seen more than enough of those in recent weeks, but one forecast did stand out. “The one theme that many agree on is that crude oil prices should remain strong in the foreseeable future,” reports Ms. Hruska.
This is the foundation on which all the other steps are built. If the outlook for oil prices isn’t optimistic, there’s no deal.
With that optimism, it made sense to look at “a junior oil company that has an excellent valuation as its stock price has moved up very little recently,” says Ms. Hruska. “This is in comparison to some of the peer group of oil stocks that have seen their stock prices appreciate, particularly in the fourth quarter of 2009.”
Oil in the ground
Twin Butte has most of its properties in Alberta. The three major projects are at Frog Lake in the eastern part of the province, Pincher Creek in the southwest, and the Deep Basin in west-central Alberta.
The company has 109 million shares outstanding and its production stands at about 6,200 barrels of oil equivalent (BOE/d) per day. So investors aren’t betting on promises. There’s oil coming out of the ground.
Twin Butte brought in new management at the end of 2008 — people with experience in running successful junior and intermediate energy firms. The board of directors also has a sound track record, says our analyst.
In August 2009, the company announced that it was purchasing Buffalo Resources for about $120 million. This added over 3,000 BOE/d, over 1,000 of it from the Frog Lake lands. And therein lies another tale.
The heavy oil spread
Frog Lake is a joint venture with the Frog Lake First Nations, and the main product on the property is heavy oil.
Heavy oil does not flow as easily as West Texas Intermediate Crude (WTI), the oil whose price you see quoted daily in the media.
Heavy oil is so called because it has a higher density or specific gravity than light crude, Ms. Hruska explains. Because it is more difficult to refine, it receives a “spread” in price compared to light crude.
Lately, however, the spread has been better for heavy oil. Companies that produce it are getting paid more than they have in the past.
“There are many reasons why analysts believe this phenomenon is here to stay, and therefore many believe heavy oil companies are more desirable as an investment than they were in the past,” adds Ms. Hruska.
The good news from Frog Lake is that production has jumped more than 15 per cent in the short time since Twin Butte has owned it. That in turn has encouraged the company to plan to drill 40 wells in 2010. If oil prices stay firm, this will increase cash flow dramatically.
What’s more, it will put considerably more oil in Twin Butte’s product mix, bulking it up to 50 per cent from recent levels at 30 per cent.
The magic number
As you add up the virtues of a stock you’re considering, you must take an equally clear-sighted look at its vices. In the case of Twin Butte, that would be debt.
One of the main reasons the stock has languished at the starting gate, Ms. Hruska tells us, is that “the company’s debt outstanding was close to its total bank line.” Thus it had little breathing space for exploration or development.
That is getting better, she says. This month, the company sold a small property — 280 BOE/d for $13.3 million — a sale that gives it more cash and does not decrease its borrowing capability.
Now Twin Butte’s debt-to-cash-flow is less than two times, which is a “magic number” for Ms. Hruska and her colleagues. This also makes the stock’s valuation cheap compared to its peers.
Owning Twin Butte at these bargain levels, she adds, also gives investors a tantalizing “free option” on some new properties it is exploring.
That includes a light-oil play at Princess, Alberta, near a property that has already paid off handsomely for Crew Energy (TSX-CR). In just a few months, Crew’s shares rose from less than $10 to over $15 and now trade at $13.65.
But Crew has made its run. Twin Butte is waiting for its day. And after adding up the pluses and minuses, this portfolio manager thinks this is a good time to own it.
When Investor's Digest of Canada went to press, it traded at $1.21. Today it is at $1.22.
The message here is not just buy low, sell high. It is do your homework. A bargain stock is bound to be a lot better buy when you know exactly what you’re getting at that low, low price.
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