Even midsized companies, with deep inventories of development locations, a growing production and cash flow base and with relatively strong balance sheets have been orphaned by investors. This has pushed valuations of most Canadian E&P companies to seemingly unprecedented lows, trading below even proven producing reserves (PDP), and at very low cash flow multiples never seen before in the Canadian sector.
The current investment climate has been so dismal and the sell-down of Canadian energy companies during the downturn has been so overdone by the market, that boards of strong companies, including Ranging River Exploration Inc (RRX.TO) and Granite Oil Corp. (GXO.TO) have announced formal processes to evaluate alternatives to enhance shareholder value. In addition, Crescent Point (CPG.TO), which has top-tier assets as one of the larger producers in North America, has recently attracted the attention of an activist given it is so highly undervalued in the marketplace. We believe this underscores the unusually low valuations for the Canadian oil and gas sector. To top it all off, microcaps have been hit even harder than their larger peers, and are trading at levels not seen since the dot.com boom in the early 2000s. We see this as an opportunity to buy a basket of highly undervalued oil and gas companies that are positioned for when valuation revert to the norm.
Historically, the lynch pin to normalizing valuations has been sparked by opportunistic acquisitions and merger activity. Investors seeing a windfall from a takeover of one company may look to the next most likely target. So far, the M&A market in Canada has been quiet, which is likely a symptom of the current investment climate, that fails to reward companies for expanding their opportunity base, even if the assets are acquired at a bargain price. However, as the sector returns to favor through 2018 onward, we expect M&A activity to pick up again. We also expect valuations to improve after the release of better-than-expected first quarter results from the sector leaders, on the back of higher commodity prices without cost inflation.
With this in mind, we recommend companies that are highly undervalued with strong fundamentals, but with unique differentiating features or future events that can gain investor attention. We like Prairie Provident Resources Inc. (PPR:TSX) for its cash flow funded 2018 capital program that should grow production to ~6,000 boe/day. Also, in Q2/18 the company may receive a favorable ruling from an arbitration tribunal that could award substantial damages, which could be a major near-term catalyst for the stock, significantly adding to the company's balance sheet and initiating a re-rate in the marketplace.
We also like Pulse Oil Corp. (PUL:TSX.V) for its massive upside from a miscible flood enhanced oil recovery (EOR) program of its two, 100%-owned Nisku Pinnacle Reefs. The EOR project has the potential to add 2,000 bbl/day–3,000 bbl/day of light oil production, which would throw off substantial cash flows and unlock over 25 million barrels of oil equivalent of in-place volumes with potential value of $177 million ($1.39/fd share) versus a market cap of ~$14 million today. This value could be unlocked for very little investment.
And we like Point Loma Resources Ltd. (PLX:TSX), which has established a large, concentrated land base in Alberta, with a large low-cost Manville and Cardium well development inventory for expected rapid production expansion as the energy market recovers. The company also has a sizeable stake in the Duvernay Shale oil play with the likes of Crescent Point and Raging River drilling offset horizontals near Point Loma's acreage. Point Loma also has additional financial security with no bank debt and the backing of a large strategic Chinese investor that owns nearly 20% of the company.
The energy sector has been out of favor for so long now that the lack of investment combined with OPEC production cuts are pushing down global oil inventories while world economies continue to grow. This could set up the energy sector for a multiyear bull market and we believe our forgotten micro caps could easily have a 100% to 200% return for investors.
PRAIRIE PROVIDENT RESOURCES INC. – PPR:TSX
Prarie Provident had focused development of conventional oil weighted assets in the Wheatland and Princess properties in Southern Alberta and its Evi area located in the Peace River Arch area of Northern Alberta. The company also holds ~240,000 net acres in the St. Lawrence Lowland of Quebec that are prospective for the Utica Shale. The company remains highly undervalued on a cash flow, reserves and NAV basis and receives no option value for its Quebec assets.
Potential Cash Windfall from Quebec Settlement Could Rerate the Stock: Prairie Provident is seeking damages of US$188.9 million related to the termination of the rights to one of the company's licences in Quebec. The final hearing concluded in November 2017 and a ruling in the dispute and potential damages could be announced in Q2/18. Over a five-year period, Prairie Provident committed a significant amount of time and capital to securing the exploration licences, acquiring and interpreting seismic and drilling wells. We feel damages of between US$25 million to US$60 million would certainly be in the realm of possibility. Damages at the low end of this range would allow the company accelerate growth through drilling or acquisitions, and could re-rate the stock.
Excellent Q1 Drilling Results; Longer-Term Results a Potential Catalyst: Prairie Provident recently completed a six-well drill program in its Princess and Wheatland (Wayne) core areas. Initial test results exceeded expectations, including an excellent test of ~ 935 boe/d (65% oil) from a well in the Princess area. Longer-term test results could be a near-term catalyst for the stock.
Trading below PDP Value: The current market price of $0.42, Prairie Provident trades at 34% of its proven developed producing (PDP) valuation of $1.30/sh and at 24% of its total proven value of $1.79/sh.
POINT LOMA RESOURCES LTD. – PLX:TSX.V
Point Loma is highly undervalued and has a large concentrated land base with a large, multi-zoned drilling inventory to fuel growth for many years. PLX has no bank debt and positive working capital to fund low risk well recompletions, facilities expansion and drilling that should double production in H2/18. Point Loma will continue to focus on its multi-layered play types including Mannville oil, Cardium, Nordegg oil, Banff and the Duvernay Shale.
Strategically Backed by Zhongcheng Group: In 2017, Point Loma established a long-term strategic partnership with Evenergy Co. Ltd. (Evenergy). Evenergy is subsidiary of Zhongcheng Group, one of the largest privately owned independent petroleum refinery, oil products and LPG distribution and retail companies in China. Evenergy acquired its initial position last year, through a private placement priced at $0.48 (stock currently at $0.22) and was also granted the right to participate in future equity financing to maintain its pro rata ownership in PLX of 19.9%. Management and directors hold an additional 19.1% of the issued and outstanding shares acquired at an average cost of $0.55 per share versus the current market price of $0.22.
Incredibly Cheap Acquisition Boosts Production by 315 boe/day: In April 2018, Point Loma expects to complete the acquisition of 315 boe/d of net production, with 1.1 million boe of proven reserves and 2.9 million boe of proven plus probable reserves (2P) for a net adjusted cost of less than $1.0 million. The assets are located in the Gilby area within the company's west central Alberta core area and were acquired from a private company that is in receivership. The opportunistic transaction metrics are excellent with a cost of approximately $2,700 per flowing barrel, $0.80/boe for proven reserves and $0.30/boe for 2P reserves. In addition, the assets have development upside on the ~29,000 gross acres with booked proven undeveloped and probable drilling locations with multi-zone potential in the Mannville, Cardium and Duvernay shale.
Free Option Upside from Its 13,000 Net Acres in the Duvernay Shale Oil Play: Point Loma has established ~13,000 acres (20 net sections) of land within the Duvernay oil shale window. Industry interest in the Duvernay has been heightened by impressive initial oil weighted production tests results from the likes of Artis Exploration (Private), Vesta Energy (Private) and Crescent Point. As a result, land prices continue to escalate in the oil window of the Duvernay. With Crescent Point and Raging River drilling horizontals near Point Loma's acreage in the near future, Point Loma's 20 net Duvernay sections alone could be worth more than the company's current market cap.
Incredibly Cheap: Subsequent to closing the Gilby acquisition, we estimate Point Loma's production will increase to 1,100 boe/day which equates to a flowing barrel value of $11,200 per boe/day versus the peer group of $20,000 to $40,000 per boe/day.
PULSE OIL CORP – PUL:TSX.V
New Unique E&P Company: Pulse holds Manville assets in Alberta that have near-term production growth potential through low-risk well reactivations, well recompletions and development drilling. Current production of ~250 boe/day is expected to double by this summer and additional work should increase production to ~1,000 boe/day by year-end. What differentiates Pulse from its peers is the massive upside from its miscible flood Enhanced Oil Recovery (EOR) project of its two Nisku Pinnacle Reefs at Bigoray (100% W.I.).
Massive Low Risk Upside from Miscible Flood of Nisku Pinnacle Reefs: Sproule Associates Limited (Sproule) completed an assessment of the EOR project of the Nisku D and Nisku E pools. Sproule assigned an estimated discovered PIIP of 23.3 million boe, with an unrisked Best Estimate contingent resource of 6.1 million boe (91.3% oil) and an upside case of 8.1 million boe (92% oil). Nisku pinnacle reef wells are prolific producers and a successful EOR program is expected to add production of ~1,000 – 1,500 boe/day for each reef or up to 3,000 boe/day (86 % light oil) for both reefs, which would generate substantial free cash flow.
Potential Value of Up to $177 million ($1.39/fd share) Versus Market Cap of ~$14 Million Today: The average recovery factor of 52 nearby analogous reefs that have been developed with a miscible flood is approximately 80%. Assuming a recovery factor at the bottom end of the range of 55%, and a modest $15/boe cash flow netback, the potential NPV10 is $78 million ($0.61/fd share). With a recovery factor equal to the average of 80% and a $15/boe netback, the NPV10 increases to $177 million ($1.39/fd share).
Bigoray Facilities Owned 100% W.I. by Pulse: As most of the required infrastructure for the Bigoray EOR is in place, the miscible flood project requires a relatively small investment per Nisku Reef providing massive upside without the risk and significant cost of an extensive horizontal drilling program. Start-up of the injections facilities is underway with injection expected to commence in late 2018.
Bill Newman is vice president of international and domestic oil and gas research with Mackie Research Capital Corp. He has been an energy analyst for 22 years. He holds a bachelor's degree in commerce from the University of Calgary, and has a CFA designation.
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Disclosure:
1) Bill Newman: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: None. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: Within the last two years, Mackie Research Capital has managed or comanaged an offering of securities for, and received compensation for investment banking and related services from Prairie Provident Resources Inc., Point Loma Resources Ltd and Pulse Oil Corp. Bill Newman has research coverage on the following companies mentioned in this article. Prairie Provident Resources Inc., Point Loma Resources Ltd and Pulse Oil Corp. Relevant disclosures required under applicable to companies under coverage discussed in this article are available on our web site at www.mackieresearch.com. I determined which companies would be included in this article based on my research and understanding of the sector.
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