Finding a Cheap Oil Stock | Calgary’s Terra Energy Offers Growth Using Good Fundamentals and Keen Ownership

You should be skeptical if someone offers to sell you a dollar for a quarter. It’s obviously too good to be true. But such opportunities do happen, albeit rarely, in the stock market.

Take the shares of Terra Energy Corp. (TSX:TT) As of this writing, the stock is quoted at $1.75 But the company’s net asset value is more than twice that much. (Net asset value is determined by figuring out how much cash flow the company’s reserves can generate over time and putting a present value on it.)

What gives?

There are a few answers but none, in my view, are enough to keep the shares down for long. I suspect the discount will close and in relatively short order, along with what I expect will be inevitably rising gas prices, investors should do well.

Oil and gas investors are all interested in growth and Terra certainly offers that.

At the end of 2009 Terra’s total proved reserves were 28% higher than a year earlier. The company also replaced 2008 production more than fourfold on a proved and probable basis.

But while investors like growth, they don’t want it at any price. Increasing your assets by 20% is nice but not if share count grows by more than that. Per-share growth is the Holy Grail. Terra didn’t disappoint on that front either: Reserves rose sharply on that basis.

There’s more to like. Terra is a big player in the Montney play, which straddles northeastern B.C. and Alberta. A few years ago, when the Montney was hot and prices were crazy, the company sold some assets for a good buck. They bought back into the area later when prices fell. That kind of contrarian thinking is unusual in the oilpatch, where companies tend to run in lemming-like herds.

I suppose one reason the company managed its affairs by selling high and buying low is that CEO Cas Morel owns a lot of stock, about a quarter of issued and outstanding shares. Inside ownership is usually a good thing. Renowned fund manager Tom Stanley of Resolute Funds is also a big owner, as is Donville Kent Asset Management, a top-notch value investment firm that returned more than 80 per cent last year.

Now for the reasons the stock is trading for less than what it’s worth. The first may have to do with that concentrated ownership. Because about half the stock is in the hands of people who are long-term holders, the stock is not very liquid, meaning not many shares change hands on a daily basis. This is enough to discourage big investors, who may otherwise love the stock, from buying it. Why? Because they can’t acquire enough to make a difference in their portfolios. It’s just not worth buying a few shares, which is all they can get, given the limited trading volume.

Another reason may be that investors doubt the company will be taken over. Many oil and gas investors salivate at the prospect of their shares popping when the company is bought. Terra has made it clear that it wants to build, not sell, at least for now.

Another possibility was that Terra has an option to purchase more land but needs $115 million to make the deal happen (the company’s market capitalization value is only $155 million). Investors may fret that Terra will sell stock to raise the funds, and since the stock is selling below its true value, this would dilute existing shareholders.

In fact, the company very recently announced a financing to raise a little more than $20 million.

Finally, the nature of the asset mix might also play a role. Terra is weighted toward gas, which is in the doldrums. And its production is largely conventional, whereas some investors want unconventional plays.

Now for the reasons these issues may be exaggerated.

On the subject of liquidity: small investors can make a lot of money buying illiquid shares, especially if that liquidity problem will eventually fade. In my view, given how nicely Terra is growing, it’s a matter of time before the company sells shares to raise money, increasing its float and trading volume. Taking advantage of a liquidity discount, should it exit, is not a bad idea.

And while the company may not be sold imminently, it is, as mentioned, growing in an “accretive” way, i.e., on a per-share basis. Selling is not the only way to make a buck.

In terms of assets, Terra’s plan is to become more “oily,” and add unconventional production, a process that’s already well underway.

And finally, I doubt that management, given its ownership, would consider a highly dilutive share issue, no matter how badly it may want to exercise that option.

Things that are cheap rarely stay cheap forever, and there’s no question that Terra is cheap by pretty much any yardstick.

For evidence, consider that the financing I mentioned earlier was what sold at a price above the market price of the stock. That, says Jordan Zinberg of Donville Kent, is unheard of in banking circles. “Neither I nor my partner have ever seen that,” he says. That’s a clear sign that the smart money thinks the stock is very, very cheap. It may also be a sign that shrewd investors think an end to the stock price discount is imminent.

Terra is a buck trading for four bits, but it won’t be for long, in my view.

Prairie Trader is an independent overview and assessment of investments available to Albertans. Alberta Venture assumes no responsibility for the accuracy of any stock recommendations. You can send letters about this column to feedback.

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