Picking an investment thesis in these challenging resource markets has never been more paramount to investors. The downward spiral of oil prices combined with a myriad of corporate factors such as high debt and dividends has begun to challenge a significant number of companies and business models. This may lead to investors seeking refuge in other parts of the investment world but with the 40% decline in oil prices thus far, companies with extremely exciting prospects have become exceptionally unique from a valuation standpoint. But at the moment, when it comes to energy companies or anything energy related it seems no one is listening.
Before we get into which companies to take a closer look at, it is pertinent to understand what exactly you are looking for in an investment, more specifically an investor needs stocks that that will act as two things, a defensive mechanism in these volatile markets and a spring board that will outperform the rebounding resource market.
To find companies that are both defensive but also poised for growth five pieces to the puzzle have to be present: the resource, the management team, catalysts and torc, a strong balance sheet and the final piece is being into the investment at an early stage of the company’s evolution.
When investing in any oil and gas company an investor should first understand the resource. Now why is this so important in this current investment climate? The reason comes down to economics, the best resource will generally hold both solid short term economics such as recycle ratios, payouts and IRR’s but as well strong long term economic indicators such as repeatability. To invest in this idea of repeatable and economic wells one has to look at unconventional resource shale plays such as the Montney located in Alberta and more specifically at the area that extends from Kakwa to Elmworth. In Elmworth, a variety of players are targeting this incredible 200 meter (650 feet) thick resource play such as EnCana Inc (CVE:ECA) or Blackbird Energy Inc. a small cap company that quietly assembled a 47 section contiguous block of land in the heart of this play in 2013/2014. The resource in the area has allowed producers to see results such as Encana’s 4-9 well which averaged 1,100 boe/d (50% liquids) over its first 45 days of production. Blackbird’s land base which is located less than 5 miles from this well could prove to be just as prolific after they test their first two wells in Q1 2015. Furthermore with over 200 meters of charged pay there is the potential as Birchcliff Energy has suggested for up to 6-7 zones in each section- this would suggest for both Blackbird and Encana the potential for over 24 wells per section. It is this type of play that eventually attracts smart bidders such as Exxon Mobile or Petronas which acquired Celtic Exploration and Progress Energy respectively in the last energy downturn in 2012. By first picking a great resource area for your investment, you are picking a solid investment base from which capital can be raised on and that will be sought after by larger, arguably smarter players.
First of all, look at the management of company as a manager of your capital. When you invest in a company the management is effectively managing YOUR money to affect their strategy. Do you believe in their strategy and are they utilizing your capital effectively to create value? Another part to seriously dive into is insider ownership and G&A spending with these pieces you are learning whether management is buying in with their capital and how they spend their money on the day to day business operations (themselves). In this current environment it is obviously good to see insider buying and high insider ownership already established but this means a lot less if management is paying themselves egregiously high salaries and bonuses. Blackbird Energy, is one company that hits the mark on these points. Since the team was assembled in its entirety they have focused on an extremely low G&A model while also being heavily invested (current insider ownership is approximately 25%). Furthermore, they have participated in a meaningful way in each equity raise. Blackbird’s management has also employed an extremely unique and aggressive strategy of cost effective value creation through land assembly and drilling. It is this type of team, in a market such as the one we are entering which would be a good bet for managing capital as they have shown a past ability to grow an extremely low amount of cash on hand – this begs the question on how well they can grow now that they have raised a significant amount of capital ($47 million in fall of 2014). Paramount Resources Inc. management team is another great example of an invested (>50% insider ownership) and forward looking management team. The team at Paramount over the last couple years have spent a tremendous amount of effort on choosing to deploy capital into infrastructure projects which has strengthened their economics through higher liquids recovery. Blackbird’s management team though newer seems to have taken a page out of Paramount’s book with their plan to develop / control infrastructure at Elmworth. These management teams controlling two very different sized companies would hit the nail on the head for investing in this capitally restrained environment.
Catalysts and Torc
Given the high degree of volatility present in the commodity markets combined with the downward trend of oil and gas prices, having a company that has known catalysts and torc in the near future along with a propensity to surprise the market is an investment parameter that has the ability to outperform. Tourmaline Oil Corp and again Blackbird Energy Inc. both fall into the category of catalyst rich companies that offer plenty of torc that should move the market. With Tourmaline, its history of outperforming analyst estimates on production should continue as it has set itself up as a low cost producer and is able to fund a large portion of its capital expenditure program internally. Blackbird Energy stands as a unique company as it has two very significant wells currently being drilled with results due out sometime in mid-late February. If these two wells do hit their intended targets (liquids rich natural gas), the company will fundamentally change from that of a preproduction land acquisition story to that of a Net Asset Value growth company. This change along with Blackbirds constant ability to surprise the market with growth through additional land acquisitions puts its ability to yield above average returns high while also allowing it to outperform in a growth market as it did in 2014.
Balance Sheet Strength
“Cash is king” – this saying though always relevant means even more in a down market such as the one that has been experienced to date in the energy complex. Simplified though, companies with low debt, or even better yet no debt and cash on hand have the ability to whether the storm and potentially emerge even stronger than before. We are currently seeing many business models being challenged that have higher debt / cash flow multiples and dividends –which if prices persist will be cut. All of this said, it is imperative to pick companies that can take advantage of what this market will offer which is cheaper assets whether developed or undeveloped. Blackbird Energy with its $47 million raised at much higher (and less dilutive) prices will have approximately $28 million in cash post it drilling its two first Montney wells will be in a unique position for a company its size as it will (1) have the capital to whether the storm in a defensive capacity (2) be able to potentially acquire more land at extremely discounted prices emerging as a larger and more relevant entity once prices begin to rebound. The strong balance sheet and no debt also highlights Blackbird managements outlook on how to capitalize a company whereby most junior companies will generally tack on debt instruments as they are easier to obtain compared to equity – this speaks volumes on the sophistication of a relatively new management team by Canadian energy standards. This balance sheet strength investment thesis is exemplified by some of the major energy companies such as Suncor and EnCana which leading up to the price collapse began to sell off assets to bolster its financial flexibility coming into 2015.
Invest Early in a Company’s Evolution
It is not rocket science to know that investing early in the right company will yield superior gains. An investment of $1,000 in Canadian Natural Resources at its inception is worth millions today but how do pick that company and as well get in early. Since 2007 there has been less of an opportunity to get into resource companies early as the public junior oil and gas market has greatly disappeared being replaced by the private equity market financing start up energy companies- there are a few companies though with the right combination of factors in place at an early enough stage to potentially yield incredible results such as Blackbird Energy Inc. which has been discussed at length in this piece. While there is still risk in this market, by investing early in a company’s evolution the higher relative risk is rewarded with a potentially higher return.
Once oil prices start to consolidate and move higher, most names in the energy space will recover – it is in the meantime though that investors look at their investments and these parameters to pick the companies that will best whether the storm and act as a spring board to healthy profits when the recovery happens.
By. James Burgess of Oilprice.com
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