The Energy Report: Tim, how do you describe your universe of coverage?
Tim Murray: It's primarily small cap. So, I'm looking at market cap sub-CAD$500M, but we don't like to get much smaller than CAD$50M. In between, we're looking for themed ideas. The one theme that sticks out in my coverage universe is light oil. I call it my "tight light oil universe," where I cover a number of companies focusing on developing assets with horizontal multi-stage fracture stimulations. The other focus is liquids-rich natural gas, however my universe is much smaller here, I only cover two names. I like to have a bigger company in my themes, and also a couple of small exploratory plays with a bit higher risk, but with bigger bang for your buck.
TER: Under-CAD$500M market cap means that small-cap mutual funds can buy in and still get doubles and triples out of companies starting at that size.
TM: Yep, no doubt about it. In the small-cap world, you're not looking for 5% or 10% returns. You're looking for meaningful returns. For higher-risk names, doubles and triples are possible. That's what investors want out of the space, but these smaller-cap companies also carry a higher risk rating.
TER: Why light oil?
TM: When I transitioned over to Jennings Capital back in December of '09, we didn't see any meaningful short- or medium-term reasons to be in the natural gas space. However, light oil, in our eyes, looked to be gaining momentum and the emergence of horizontal drilling and multi-stage fracks looked to be opening up a number of historic oil pools that had been developed vertically. Horizontal drilling had the potential to push pool boundaries and increase recovery factors. That's exactly what happened the last two years in the basin. We still see meaningful growth potential for the light oil space at $100 oil and even lower commodity prices.
TER: You have so many buy-rated names in your universe of coverage. Does this mean that there's a tremendous amount of value in small-cap oil and gas plays currently?
TM: The reason there are lots of buys in my universe is because we've got a pretty straightforward rating schedule. If my target price is over a 10% return, it must be a buy. As I mentioned earlier, in the small-cap world you need meaningful upside to justify the added risk so investors should really focus on my names with returns north of 20% and—for some of my riskier names—north of 50% would be ideal. I think there's a lot of value to be found among small caps if oil remains above $95 per barrel.
If you are of the belief that there might be some short-term pullback in the price of oil, then you've got to be a little bit more selective. What I'd be looking for are companies with good balance sheets in order to complete meaningful capital programs and lots of future running room upon success. I think the downside risk is minimal on most of my light oil names assuming we stay above USD$95/bbl oil as light oil-focused companies should generate meaningful cash flow and balance sheets should remain strong. The one wild card will be operational success and the market will reward the companies that demonstrate this.
TER: Are these companies in your universe actually growth stories, and can they continue to be growth stories if the price of oil remains stable?
TM: Yes. Most of the names I cover in my small-cap universe are growth companies. There's only one that I would call a modest-growth story from a production standpoint: Equal Energy Ltd. (TSX:EQU; NYSE:EQU). If oil stays above USD$95/bbl, the companies in my light oil universe are all generating meaningful cash flow relative to their size. And the smaller ones, such as Novus Energy Inc. (TSX.V:NVS), Torquay Oil Corp. (TSX.V:TOC.A; TSX.V:TOC.B), Reliable Energy Ltd. (TSX:REL), could double and triple production in the next two years.
TER: What else are you telling investors?
TM: Obviously, we like the light oil space in general, and another name I like that is the cheapest in our light oil space is Renegade Petroleum Ltd. (TSX.V:RPL). This story has been a laggard in my light oil coverage group as they missed guidance targets the last couple of quarters, so the market's a little bit leery of the story. However, this is one of the cheaper names in my light oil space and we do like the company's assets and believe they should be able to add meaningful production into 2012. Renegade has also drilled its first exploratory horizontal Bakken well in Renville, North Dakota, which has seen very little Bakken activity. The well is currently waiting on a frack crew, so we should have well results out closer to the third quarter. They have access to 48 gross sections (50% working interest) so meaningful running room upon success.
TER: Will Renegade's cash flow support its capital expenditure requirements? Will it necessarily have to go back to the market?
TM: The company did an equity raise of CAD$46M early this year and recently received an increase to its bank, so it has lots of capacity on the balance sheet to fund the going forward capital program.
The tightest light oil company in my universe, balance sheet-wise, is Midway Energy Ltd. (TSX:MEL). If the company can hit our production forecasts, it should be fine. However, any operational hiccups could lead to the balance sheet becoming extremely stretched.
I also have two "W" companies, WestFire Energy Ltd. (TSX:WFE) and Wild Stream Exploration Inc. (TSX.V:WSX). I like both of these companies, which are once again both targeting light oil. WestFire has two Viking plays—one in Redwater, and the other in Dodsland. I think there's considerable running room on the Dodsland area in Saskatchewan and WestFire has had tremendous success to date at Redwater.
TER: Is there any stimulus or catalyst that could move WestFire?
TM: Oh, for sure. Right now the bulk of the first quarter activity was at Redwater. NAL, along with several other operators, have regulatory approval to drill 32 wells per section, but I only carry 12 wells per section in my models. I must point out that NAL's 32-well design carries a smaller recovery factor per well than my 12 wells, however, this generally shows the ultimate recovery factors could be larger than we currently assign. WestFire will also become active again in the greater Dodsland area after spring break up and this is the company's largest asset, so any exploratory success should help move the stock higher.
TER: The reason I ask about catalysts is because WestFire's market cap is already up to CAD$386 million and the company's shares are up almost 60% in the last six months.
TM: Many of the light oil stories have appreciated since Q410 due to good operational success and the rising oil price. WestFire is one of those as we were pushing the story hard in the summer months (around August) when it had sold off quite a bit and we thought that it was overdone. Since then, the story has rallied very hard, and outperformed the peer group early into 2011. We still think there's significant long-term value in the WestFire story as the company has a very large inventory of light oil wells. It just needs to spend additional capital to prove up the resource and, ultimately, capture the value in the ground.
I couple that with my other "W" story, Wild Stream, which has assets in Saskatchewan and Alberta. To date, it's done the best in adding production and reserves of my light oil space. Through acquisitions, they have added acreage and production in all its core areas, giving them further running room. It has three light oil plays and there is an emerging fourth, so, it's probably the deepest of the juniors that I cover and also the largest in size. I like the scope of all its plays and we expect its first horizontal well on the fourth light oil play at Swan Hills in the second half of 2011. Wild Stream did lag our light oil group in early 2011, however, we think it's very well positioned going forward and momentum should pick up again in the second half of the year.
TER: You mentioned Equal Energy. You wrote a research note saying it was very cheap. It sounds like a value.
TM: Yeah, it's definitely a value play right now. It trades well below our 1P net asset value (NAV) of $10.40 per share and 2P NAV of $12.35. Most companies trade closer to their 2P NAV and we think Equal should trade at least in-line with our 1P NAV of $10.40. On top of this, we feel the reserve report is modestly booked on a 2P basis, giving investors further exposure to the upside.
We don't model Equal actually growing in production this year, but it's not a major concern to us because the company has moved all its capital to focus on light oil and liquids-rich prospects. Even though production is relatively flat, we see cash flow increasing 30% year over year, which we believe should help fund production growth in the future.
Equal has three light oil plays, two of which are in Canada, the Alliance Viking play in the Halkirk area and the Cardium light oil play at Lochend. Equal also has an emerging Mississippian play on its Oklahoma assets, which SandRidge Energy Inc. (NYSE:SD) and Chesapeake Energy Corp. (NYSE:CHK) are chasing very hard. Equal has very little booked in its year-end reserve report for the Viking and Cardium and nothing for the Mississippian play, once again exposing investors to further upside.
TER: The market has been very fond of this play. It looks like it is up 71% over the past six months and 31% over the past three months, and you have a 40% implied upside from current levels. Could Equal still represent lower risk than many of your plays?
TM: Yeah. We think the downside on this company is marginal as it trades below our 1P NAV. The next task for management is demonstrating success on its three light oil plays and further activity on the liquids-rich Hunton asset should help with further momentum for the stock. Ultimately if the market is not willing to extend value to its assets they may have to look to industry and sell some assets and become either focused in Canada or the US.
TER: Are there any other types of plays you like?
TM: There is one other I would like to highlight. Palliser Oil & Gas Corp. (CVE:PXL) is focused on heavy oil, primarily in Saskatchewan. The company is targeting legacy heavy oil pools that are well-defined and looking at increasing recovery factors by applying some more modern technology as several of the pools were drilled up to 20 years ago. It is employing a technique called High Volume Lift (HVL), which is essentially putting on higher-rate pumps as the water cuts increase on the wells. The company has had some very good success to date with this application. We carry essentially no upside for the HVL technique in our models as we would like to see some further production data on the wells first. The stock did very well early in 2011 and recently has sold off. At current levels, we think the stock is very attractively priced.
TER: Best wishes, Tim. Thank you.
TM: Much appreciated.
Prior to joining Jennings Capital Inc. in December 2009, Tim Murray held the position as an Oil & Gas Analyst at Salman Partners Inc. and Northern Securities Inc. covering junior and mid-cap companies. Tim spent over a year at AltaGas Income Trust performing risk and credit analysis on the company's midstream business for natural gas and power assets. Prior to that, he was an Investment Advisor for three years. Tim obtained his CFA in 2003.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Equal Energy, Ltd.
3) Tim Murray: I and/or my family personally own shares of the following companies mentioned in this interview: None. Jennings Capital Inc., Jennings Capital (USA) Inc. and/or any affiliates received compensation for investment banking and related services from Equal Energy Ltd., Palliser Oil & Gas Corp., Renegade Petroleum Ltd., Torquay Oil Corp., and WestFire Energy Ltd., in the past 12 months.
Tim Murray: It's primarily small cap. So, I'm looking at market cap sub-CAD$500M, but we don't like to get much smaller than CAD$50M. In between, we're looking for themed ideas. The one theme that sticks out in my coverage universe is light oil. I call it my "tight light oil universe," where I cover a number of companies focusing on developing assets with horizontal multi-stage fracture stimulations. The other focus is liquids-rich natural gas, however my universe is much smaller here, I only cover two names. I like to have a bigger company in my themes, and also a couple of small exploratory plays with a bit higher risk, but with bigger bang for your buck.
TER: Under-CAD$500M market cap means that small-cap mutual funds can buy in and still get doubles and triples out of companies starting at that size.
TM: Yep, no doubt about it. In the small-cap world, you're not looking for 5% or 10% returns. You're looking for meaningful returns. For higher-risk names, doubles and triples are possible. That's what investors want out of the space, but these smaller-cap companies also carry a higher risk rating.
TER: Why light oil?
TM: When I transitioned over to Jennings Capital back in December of '09, we didn't see any meaningful short- or medium-term reasons to be in the natural gas space. However, light oil, in our eyes, looked to be gaining momentum and the emergence of horizontal drilling and multi-stage fracks looked to be opening up a number of historic oil pools that had been developed vertically. Horizontal drilling had the potential to push pool boundaries and increase recovery factors. That's exactly what happened the last two years in the basin. We still see meaningful growth potential for the light oil space at $100 oil and even lower commodity prices.
TER: You have so many buy-rated names in your universe of coverage. Does this mean that there's a tremendous amount of value in small-cap oil and gas plays currently?
TM: The reason there are lots of buys in my universe is because we've got a pretty straightforward rating schedule. If my target price is over a 10% return, it must be a buy. As I mentioned earlier, in the small-cap world you need meaningful upside to justify the added risk so investors should really focus on my names with returns north of 20% and—for some of my riskier names—north of 50% would be ideal. I think there's a lot of value to be found among small caps if oil remains above $95 per barrel.
If you are of the belief that there might be some short-term pullback in the price of oil, then you've got to be a little bit more selective. What I'd be looking for are companies with good balance sheets in order to complete meaningful capital programs and lots of future running room upon success. I think the downside risk is minimal on most of my light oil names assuming we stay above USD$95/bbl oil as light oil-focused companies should generate meaningful cash flow and balance sheets should remain strong. The one wild card will be operational success and the market will reward the companies that demonstrate this.
TER: Are these companies in your universe actually growth stories, and can they continue to be growth stories if the price of oil remains stable?
TM: Yes. Most of the names I cover in my small-cap universe are growth companies. There's only one that I would call a modest-growth story from a production standpoint: Equal Energy Ltd. (TSX:EQU; NYSE:EQU). If oil stays above USD$95/bbl, the companies in my light oil universe are all generating meaningful cash flow relative to their size. And the smaller ones, such as Novus Energy Inc. (TSX.V:NVS), Torquay Oil Corp. (TSX.V:TOC.A; TSX.V:TOC.B), Reliable Energy Ltd. (TSX:REL), could double and triple production in the next two years.
TER: What else are you telling investors?
TM: Obviously, we like the light oil space in general, and another name I like that is the cheapest in our light oil space is Renegade Petroleum Ltd. (TSX.V:RPL). This story has been a laggard in my light oil coverage group as they missed guidance targets the last couple of quarters, so the market's a little bit leery of the story. However, this is one of the cheaper names in my light oil space and we do like the company's assets and believe they should be able to add meaningful production into 2012. Renegade has also drilled its first exploratory horizontal Bakken well in Renville, North Dakota, which has seen very little Bakken activity. The well is currently waiting on a frack crew, so we should have well results out closer to the third quarter. They have access to 48 gross sections (50% working interest) so meaningful running room upon success.
TER: Will Renegade's cash flow support its capital expenditure requirements? Will it necessarily have to go back to the market?
TM: The company did an equity raise of CAD$46M early this year and recently received an increase to its bank, so it has lots of capacity on the balance sheet to fund the going forward capital program.
The tightest light oil company in my universe, balance sheet-wise, is Midway Energy Ltd. (TSX:MEL). If the company can hit our production forecasts, it should be fine. However, any operational hiccups could lead to the balance sheet becoming extremely stretched.
I also have two "W" companies, WestFire Energy Ltd. (TSX:WFE) and Wild Stream Exploration Inc. (TSX.V:WSX). I like both of these companies, which are once again both targeting light oil. WestFire has two Viking plays—one in Redwater, and the other in Dodsland. I think there's considerable running room on the Dodsland area in Saskatchewan and WestFire has had tremendous success to date at Redwater.
TER: Is there any stimulus or catalyst that could move WestFire?
TM: Oh, for sure. Right now the bulk of the first quarter activity was at Redwater. NAL, along with several other operators, have regulatory approval to drill 32 wells per section, but I only carry 12 wells per section in my models. I must point out that NAL's 32-well design carries a smaller recovery factor per well than my 12 wells, however, this generally shows the ultimate recovery factors could be larger than we currently assign. WestFire will also become active again in the greater Dodsland area after spring break up and this is the company's largest asset, so any exploratory success should help move the stock higher.
TER: The reason I ask about catalysts is because WestFire's market cap is already up to CAD$386 million and the company's shares are up almost 60% in the last six months.
TM: Many of the light oil stories have appreciated since Q410 due to good operational success and the rising oil price. WestFire is one of those as we were pushing the story hard in the summer months (around August) when it had sold off quite a bit and we thought that it was overdone. Since then, the story has rallied very hard, and outperformed the peer group early into 2011. We still think there's significant long-term value in the WestFire story as the company has a very large inventory of light oil wells. It just needs to spend additional capital to prove up the resource and, ultimately, capture the value in the ground.
I couple that with my other "W" story, Wild Stream, which has assets in Saskatchewan and Alberta. To date, it's done the best in adding production and reserves of my light oil space. Through acquisitions, they have added acreage and production in all its core areas, giving them further running room. It has three light oil plays and there is an emerging fourth, so, it's probably the deepest of the juniors that I cover and also the largest in size. I like the scope of all its plays and we expect its first horizontal well on the fourth light oil play at Swan Hills in the second half of 2011. Wild Stream did lag our light oil group in early 2011, however, we think it's very well positioned going forward and momentum should pick up again in the second half of the year.
TER: You mentioned Equal Energy. You wrote a research note saying it was very cheap. It sounds like a value.
TM: Yeah, it's definitely a value play right now. It trades well below our 1P net asset value (NAV) of $10.40 per share and 2P NAV of $12.35. Most companies trade closer to their 2P NAV and we think Equal should trade at least in-line with our 1P NAV of $10.40. On top of this, we feel the reserve report is modestly booked on a 2P basis, giving investors further exposure to the upside.
We don't model Equal actually growing in production this year, but it's not a major concern to us because the company has moved all its capital to focus on light oil and liquids-rich prospects. Even though production is relatively flat, we see cash flow increasing 30% year over year, which we believe should help fund production growth in the future.
Equal has three light oil plays, two of which are in Canada, the Alliance Viking play in the Halkirk area and the Cardium light oil play at Lochend. Equal also has an emerging Mississippian play on its Oklahoma assets, which SandRidge Energy Inc. (NYSE:SD) and Chesapeake Energy Corp. (NYSE:CHK) are chasing very hard. Equal has very little booked in its year-end reserve report for the Viking and Cardium and nothing for the Mississippian play, once again exposing investors to further upside.
TER: The market has been very fond of this play. It looks like it is up 71% over the past six months and 31% over the past three months, and you have a 40% implied upside from current levels. Could Equal still represent lower risk than many of your plays?
TM: Yeah. We think the downside on this company is marginal as it trades below our 1P NAV. The next task for management is demonstrating success on its three light oil plays and further activity on the liquids-rich Hunton asset should help with further momentum for the stock. Ultimately if the market is not willing to extend value to its assets they may have to look to industry and sell some assets and become either focused in Canada or the US.
TER: Are there any other types of plays you like?
TM: There is one other I would like to highlight. Palliser Oil & Gas Corp. (CVE:PXL) is focused on heavy oil, primarily in Saskatchewan. The company is targeting legacy heavy oil pools that are well-defined and looking at increasing recovery factors by applying some more modern technology as several of the pools were drilled up to 20 years ago. It is employing a technique called High Volume Lift (HVL), which is essentially putting on higher-rate pumps as the water cuts increase on the wells. The company has had some very good success to date with this application. We carry essentially no upside for the HVL technique in our models as we would like to see some further production data on the wells first. The stock did very well early in 2011 and recently has sold off. At current levels, we think the stock is very attractively priced.
TER: Best wishes, Tim. Thank you.
TM: Much appreciated.
Prior to joining Jennings Capital Inc. in December 2009, Tim Murray held the position as an Oil & Gas Analyst at Salman Partners Inc. and Northern Securities Inc. covering junior and mid-cap companies. Tim spent over a year at AltaGas Income Trust performing risk and credit analysis on the company's midstream business for natural gas and power assets. Prior to that, he was an Investment Advisor for three years. Tim obtained his CFA in 2003.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Equal Energy, Ltd.
3) Tim Murray: I and/or my family personally own shares of the following companies mentioned in this interview: None. Jennings Capital Inc., Jennings Capital (USA) Inc. and/or any affiliates received compensation for investment banking and related services from Equal Energy Ltd., Palliser Oil & Gas Corp., Renegade Petroleum Ltd., Torquay Oil Corp., and WestFire Energy Ltd., in the past 12 months.
