Why it might be time to look at small cap energy stocks like Canacol
Burger Time: why you should be happy that junior producers have been savaged of late
Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks
by Jody Chudley
If you have been invested in Canadian small cap oil and gas producers over the past year you likely haven’t been having much fun. I know I haven’t. The S&P/TSX Venture Composite Index, which is where virtually all of those companies are listed in Canada, has declined by 30 per cent over the last 12 months. That’s a pretty shocking decrease, and all the more so given that the major indices in the United States have been busy making all-time highs.
However, if you are someone who is interested in owning small cap oil and gas producers for the long term, then this market decline is a welcome event. Warren Buffett explained why in his 1998 letter to Berkshire Hathaway shareholders: “A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
“But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”
Lower stock prices mean better valuations. Better valuations mean better returns over the long term. Rather than grumble about this market decline, long term oil and gas investors should view it as opportunity. One of the best right now, in my view, is Canacol Energy, which has a chart that only a short seller could love. Canacol is a relatively young company focused on Colombia. The company was incorporated as a private company in January 2008 and then entered the public
markets on June 9, 2008 through a reverse takeover.
From 2008 through mid-2012, Canacol was mostly a pure exploration company. But last October it announced that it was entering into a business combination with Shona Energy. This transaction added a stable base of profitable natural gas production (long term contracted prices of $5.25/mcf and netbacks of $4.40/mcf) and cash flow to Canacol’s more volatile exploration business model.
As of today Canacol has the following main assets: the Rancho Hermosa light-oil field, and LLA exploration block and Esperanza gas field in Colombia; the Atacapi and Libertador oil fields in Ecuador; the Capella heavy-oil field in Colombia; and the middle and upper Magdalena shale oil Basin in Colombia. I believe that at the current stock price investors are paying an attractive price for the first three assets, thereby receiving the Capella heavy oil and Magdalena assets for free. I think that could be a rewarding proposition, but the question then becomes whether the heavy-oil and shale-oil assets have much value.
Canacol has entered three joint ventures with some very respectable companies on three of its shale-oil blocks. Shell purchased from Canacol an 80 per cent interest in block VMM 3 for $1,140 per acre; ExxonMobil purchased an 80 per cent interest in block VMM 2 for $774 per acre and ConocoPhillips purchased a 70 per cent interest in block Santa Isabel for $3,004 per acre. That implies that the acreage retained by Canacol in each of those blocks is worth $11.6 million, $19.3 million and $90.1 million respectively, or $121 million in total – and $1.38 per share.
The heavy-oil blocks might also have significant value in their current form. Canacol has 1.1 million net acres near the previously discovered and producing Capella heavy-oil field. Canacol secured this large acreage position for $33 per acre. Recent land transactions adjacent to Canacol’s acreage have taken place at prices ranging $155 to $209 per acre range. At $155 per acre those heavy oil assets would be worth $170 million or $1.94 per share. At $209 per acre those heavy oil assets would be worth $229 million or $2.62 per share.
Added together, Canacol appears to offer a great deal of upside with limited downside. The current share price just north of $3 per share appears to be well supported by the value of Canacol’s production, reserves and cash flow. In addition to those assets, Canacol has shale-oil blocks which appear to be worth $1.38 per share and heavy-oil blocks which appear to be worth at least $2 per share. Add all of those together and it puts the value of Canacol at well over $6 per share, or more than double the current share price. That looks like a tasty hamburger to me.