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Scott Koyich: Oil & Gas Upside Potential
Source: Karen Roche and Gordon Holmes of The Energy Report (9/14/10)
To take advantage of the upside potential when oil and gas cycles take a turn for the better, without exposing yourself to the brunt of the downside risk, make your best picks on the basis of strength in assets and management. Scott Koyich, who founded Calgary-based DSK Consulting Ltd. and Brisco Capital Partners, focuses on his top picks in this Energy Report exclusive.
Scott Koyich: On a macro basis, we are in a very tough time in the world today. It's now more important than ever to protect capital and to focus your investment choices. In the energy sector, oil has corrected dramatically in the past weeks. That's due to both nervousness around storage numbers and global consumer and industrial demand. This has left a worldwide bearish feeling surrounding the commodity. It's my opinion the OPEC countries need to balance their budgets on an $85/barrel oil price and I think we will see it hover around there going forward.
Natural gas prices have been in the dog house for quite some time in North America due to lack of industrial demand and the perceived abundance of supply from the unconventional discoveries in the U.S. and growing supplies of liquefied natural gas (LNG) worldwide.
The cycles normalize, eventually, and will turn in a positive direction; therefore, if you pick companies with strong management, balance sheets, asset bases and discount-to-enterprise value, your portfolio should do well on the turnaround.
TER: For example?
SK: An example on the international forefront is TransGlobe Energy Corporation (TSX:TGL; NASDAQ:TGA). This company's been around for quite some time and has built its production base to approximately 10,000 barrels of oil per day (bopd)—and that's 100% oil. TransGlobe, at its current reserve base, now sits on the radar of potential acquirers wishing to diversify out of their U.S. dollar reserve base by purchasing oil assets. China, India, Korea and sovereign wealth funds are examples of such acquirers. We know this because of recent purchases in TransGlobe's peer group in North and West Africa. TransGlobe could potentially double its reserve base in the next 24–30 months and become an even more favorable acquisition target.
An example on the natural gas side is domestic producer, Vero Energy Inc. (TSX:VRO). Even in a depressed natural gas environment, Vero has earnings-positive numbers and continues to show 100% drilling success. Its full cycle costs still show good numbers in this $4–$5 Natural Gas Exchange (AECO) pricing environment. The key for Vero is the high heating-content gas it's discovering and the 20–45 barrels of liquids production for every million cubic feet they produce. Vero had a NAV of CAD$9.67 last year and is currently trading at around $6. This is another example of buying value. The company will bring its gas-to-oil mix down from the current level of 79%–21% to 72%–28% by year-end. Vero is positioned strongly to take advantage of the next positive cycle and, if the market doesn't recognize this gem, its peer group will.
TER: You mentioned that the commodity cycle needs to turn around. Would an investor in Vero or TransGlobe expect to see a flat stock price until that turnaround?
SK: That's a good question. I tell investors on a day-to-day basis to play only the money they can afford to lose and make sure they wade into a position—rather than jump in with both feet. For instance, you have an idea about the size of position you wanted to take in Vero Energy, say 10,000 shares. On a down day, bid a position for 5,000; if you get filled right away, watch the stock to see how it plays out (this could take days to execute). If the stock goes down or up over time, average down or up to a full position. Personally, I am very comfortable with Doug Bartole's management team at Vero, the balance sheet, oil and gas properties and the future of natural gas; so, if Vero goes down after my initial wade-in position, I am comfortable with averaging down.
TER: If it's trading below enterprise value now, do you expect it to reach enterprise value before the sector turns around, or is that too optimistic?
SK: If any stock has a chance it is Vero. The company is covered by approximately 12 investment banks, BMO Nesbitt, RBC, First Energy and GMP to name a few. You want to be invested in well-covered equities because they will be the first to go back toward stronger multiple levels. Institutional sales desks and analysts, conditionally, will start calling their clients once they become comfortable with the macro environment, and then suggest their clients build positions in junior natural gas stocks for leverage. The more coverage you have, logic dictates, the better chance the undervalued equity will have to move back to its former glory. The stock has moved through $9 several times and had a high of $11.20 (2008)—if anything, it is a great trade on natural gas. As soon as the macro environment turns, you want to make sure you're vested in stories like Vero; unfortunately, timing is the most difficult part.
If we have a cold winter and decent drawdowns on storage, the natural gas market will pick up this winter. This will start investment banks marketing Vero. Normally, the well-covered, undervalued equities move first.
TER: Both Vero and TransGlobe have made nice run-ups and have been somewhat locked in a trading band. From a technical standpoint, I read this as very positive.
SK: TransGlobe sat in a holding pattern between approximately CAD$2.50 and CAD$3.50 for what seemed forever. Management realized how undervalued the stock was and commenced on a yearlong road show across the globe. It wasn't until an analyst tour to Egypt earlier this year that the world then read about the true blue-sky potential of TransGlobe Energy. The analysts needed to understand the reserve potential of the West Gharib Concession. By vertically fracing 30–40 bopd wells and turning them into 300–600 bopd wells, as well as showing the number of future locations, it wasn't hard for them to see its true potential. The stock went north of $8 and has stabilized in the mid $7s. TransGlobe was the first in Egypt to execute on a multi-frac horizontal well. Investors are anxious to see if the horizontal (multi-frac) is the key to unlocking further potential, or if the company continues along the vertical frac path they're currently on. A science project, if you will.
This is no different than the ongoing science project in the North American sedimentary basin—on fields, such as the Bakken or Cardium. You have to determine the most cost-effective way to establish reserves and optimum production with the various drilling techniques. TransGlobe is trading at current levels and will likely continue to until the world sees what reserve potential is unlocked. And, as potentially positive news unfolds, we may see TransGlobe move to the next price level. Vero is doing the same thing with its 103 net sections in the Cardium. By drilling horizontal multi-frac wells and increasing its oil weighting, TransGlobe will show the investment community they are not just another oil stock.
TER: Any other thoughts on the energy area?
SK: We continue to like the international stories; they have done well for us in the past. From 2002–2007, we represented a TSX-listed oil and gas company with properties in Egypt called Centurion Energy. Centurion was bought by Dubai-listed Dana Gas (ADX:DANA) in February 2002 for $1.2 billion, or $12/share. Fast forward to today, this management team is attempting a repeat with Sea Dragon Energy Inc. (TSX.V:SDX). You never want to bet against CEO Said Arrata; his connections with the Egyptian government are second to none and this CAD$0.25 junior may become a great leverage play going forward. The big difference between Sea Dragon and Centurion is the number of shares outstanding. Sea Dragon has nearly 4 times the number of shares outstanding than Centurion did.
TER: Do you see that as a problem?
SK: Not necessarily; but, in an uncertain capital market like this, you have to be careful. It's very difficult to manage a large float in a value-based market. Institutions tend to look at market cap and evaluation carefully. On the other side, Said and his team have done a great job getting to 1,400 bopd already and back filling the valuation.
TER: Any other companies that come to mind?
SK: Brownstone Ventures Inc. (TSX.V:BWN) is a labor of love for celebrated investment personality, Sheldon Inwentash of Pinetree Capital Ltd. (TSX:PNP). Sheldon, who is well known in the resource world, has done a spectacular job of picking natural resource equities. Through Brownstone, Sheldon has amassed an amazing inventory of non-operated oil and gas interests in countries all over the world. Brownstone sits as one of Pinetree's largest holdings, and Sheldon is chairman of the board.
Currently, Brownstone has cased a well onshore Colombia north of 15,000 feet with joint venture partners Quetzal Energy Ltd. (TSX.V:QEI) and Condor Resources Inc. (TSX.V:CN). Anyone following the excitement in Colombia knows this country has become an investment class of its own. With the likes of Gran Tierra Energy Inc. (NYSE:GTE; TSX:GTE) and Petrolifera Petroleum Ltd. (TSX:PDP) leading the charge, the investment community should become very interested in the drilling results to come from Brownstone by mid-October. This could be the first of Brownstone's many production successes to come. I love these stories—trading below last-issue price of $0.55 with a strong balance sheet and great management and board of directors—all the ingredients for potential share appreciation.
TER: You say you expect to see results coming from Brownstone soon?
SK: Yes, we should see results in the end of September to mid-October timeframe. We have our fingers crossed, but initial indications from the Brownstone team are very positive. With any positive press results, Chairman Sheldon's finger at the pulse of Bay Street and Brisco Capital taking management on the road this fall, this could create a perfect storm for Brownstone.
TER: Any other energy companies you want to tell us about?
SK: One of the common themes of our investment mandates is leverage. We at Brisco Capital love stories that have a chance at multiples on share appreciation. One of your articles mentioned a client of ours—BioExx Specialty Proteins Ltd. (TSX.V:BXI). This story has had an incredible run, as potentially the first company in history, to commercialize canola proteins. We started with this company at CAD$0.25 cents and it currently sits at CAD$2.20,
We want to bring an energy supplier to your readers' attention. Cortex Business Solutions Inc. (TSX.V:CBX). Cortex is a service company that streamlines procurement processes and supply chain management. At this point, Cortex has focused on the O&G sector due to its location in Calgary, Canada—the home of approximately 100 Canadian energy company head offices. The beta client for Cortex has been Husky Energy Inc. (TSX:HSE). In any one given month, Husky used to receive approximately 350,000 pieces of mail in the form of purchase orders, goods and services receipts and invoices. Once the data-entry process, reconciliation, payment approval and check run were completed, the suppliers were lucky to receive payment in roughly 60–120 days. Cortex has automated the process for Husky and approximately 3,000 (growing monthly) of its top invoicing suppliers. Now, Husky is capturing early pay discounts from its supply chain and has trimmed its administrative department dramatically.
The supply chain—Precision Drilling Corp. (TSX:PD), Schlumberger Ltd. (NYSE:SLB), etc.—has been happy to comply, as they're paid on contract terms (net 30 days) and have even moved to weekly pay schedules. In Q1 of this year, Cortex signed up Bonavista Energy Trust Ltd. (TSX:BNP.UN), Murphy Oil Corp.'s (NYSE:MUR) Canadian division and Apache Corporation—Canada (NYSE:APA). Cortex gets paid by the suppliers on integration and monthly access fees and per transaction. The more suppliers that join the network, the more transactions between the hubs and suppliers—and amongst the suppliers themselves. This story could become viral going forward. Apache North America has gone live this month in Canada and will go live in the U.S. by year-end.
TER: Very interesting.
SK: Another compelling thing about Cortex is that the crossover rate between energy companies and their supplier base is anywhere from 45%–65%; therefore, it's very easy to hook up crossover suppliers when a new hub signs on. Also, Apache's recent purchase of BP Plc's (NYSE:BP; LSE:BP) North American asset base for approximately $9 billion was the equivalent of Cortex signing two more hubs to the network. This spring, well-known resource investor Sprott Asset Management participated for roughly $5M of a $7M bought-deal financing at CAD$0.50/share (no warrant). In fact, Sprott Portfolio Manager Jamie Horvat named Cortex one of his top picks due to its viral, transactional revenue nature. Most likely you will see Cortex move organically into the mining and construction sectors next.
TER: Interestingly enough, that was the top pick of Taylor McDonald, whose Energy Report interview just ran on August 25. He talked about Cortex as a niche player, a "tech special situation" that solves problems that resource companies are experiencing.
SK: Taylor MacDonald, through his fund at Pathfinder Ventures, has been a great supporter of the story for some time now. The key to success for these technology stories is finding the reoccurring revenue models that are viral in nature. Cortex has provided guidance to the Street that it could be cash flow positive, on a transactional-revenue basis, by Q211 (ending January 31, 2011), which means all other revenue streams flow right to the bottom line. Analysts love these stories due to their predictable revenue streams and guidance—the kind they would have loved to write about in 1999, prior to the technology crash.
TER: Very good.
SK: That's a leverage pick—the kind you want, with big leverage to it. So, you want to have stories in your portfolio that have the chance of making 5, 10 or 15 times your money over a number of years, right?
TER: Any other last thoughts you'd like to share?
SK: On the leverage side, Pacific Wildcat Resources Corp. (TSX.V:PAW). I mentioned this one in my interview with The Gold Report. This client was referred to us through PAW Board Member Terry Lyons, who also sits on the board of directors at Canaccord Financial Inc. (TSX:CF). We like this deal, not just because it's trading at approximately CAD$0.20. but also due to its management expertise and properties. The CEO, located in Perth, Australia, has assembled two great plays located near infrastructure. The first property is quick to cash flow in Mozambique. They are forecasting this project will be up and producing tantalum by February 2011. Management has stated this property will earn $2M–$3M a year at full ramp-up. They also have a rare earth-niobium project in Kenya. You couldn't ask for better infrastructure near your properties or stronger management. We haven't taken this company on the road yet because it's in the middle of a $0.22 non-brokered financing. Watch for this hidden jewel—another example of potential leverage in 2010–2011.
TER: Terrific. Thanks, Scott.
Scott Koyich is a Calgary-based entrepreneur with over 10 years of experience in the investor relations industry. He is the president and CEO of DSK Consulting Ltd. and chairman of Brisco Capital Partners, both of which provide high-level advisory and strategic communications advice, investor relations and communication services. They are private firms representing various publicly traded companies that are listed on the Toronto Stock Exchange and the TSX Venture Exchange—including a number in the resources sector, such as Antares Minerals, Bellatrix Exploration, BioExx Extraction Technologies, Bridge Resources, Canadian Energy Exploration, Dynasty Metals & Mining, Galway Resources, Sea Dragon Energy, Sunward Resources, Tonbridge Power, TransGlobe Energy, Vero Energy and Ucore Rare Metals. Scott also has a passion for life that often crosses over into other business environments; he is a partner in two of Western Canada’s top restaurants, Il Sogno (Calgary, AB) and Cabana Grille (Kelowna, B.C.) and also co-producer of Hollywood and Vines, starring his business partners and Canadian celebrities, Terry David Mulligan and Jason Priestley.
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1) Karen Roche and Gordon Holmes of The Energy Report conducted this interview. Karen personally and/or her family own shares of the following companies mentioned in this interview: None. Gordon Holmes: From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
2) The following companies mentioned in the interview are sponsors of The Energy Report: TransGlobe Energy Corp.
3) Scott Koyich, DSK Consulting Ltd. (DSK): DSK is an investor relations firm. DSK provides, for remuneration, corporate communications and investor relations services to client companies represented in this interview. The information contained in this interview is based on existing disclosure documents or other publicly available information. Neither DSK nor the above-mentioned client(s) are offering securities, advising or soliciting the purchase or sale of securities. Information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. This material is not an offer to sell or a solicitation of an offer to buy any securities, nor is it an endorsement of the companies by DSK. DSK is not responsible for any claims made by the companies. Investors should independently investigate and fully understand all risks before investing. Statements included may contain forward-looking statements within the meaning of the Private Securities Litigation Reform ACT of 1995. Such statements may involve a number of risks and uncertainties. Further information on potential factors that may affect each company's financial results can be found in their specific financial reports, which are filed with the Securities and Exchange Commission (SEC) and/or the British Columbia Securities Commission (BCSC).