On The Money: Tamarack Valley Energy & its Cardium assets
This small cap producer has two things investors need to look for: a discounted valuation, and the ability to survive in today’s market
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 there is a more beaten down index of stocks in the world than the resource-heavy S&P/TSX Venture Composite, I don’t know what it is. For those of us who own Canadian small cap resource companies, the panic experienced in 2008 has returned with full force. I didn’t particularly enjoy the second half of 2008 and the first quarter of 2009, when the world seemed to be falling apart, but the experience was valuable. While I remember the rapid downward drop in stock prices quite vividly, I also remember the equally rapid recovery that followed.
Am I saying that now is the bottom for Canadian resource stocks?
Hardly. Like every other investor, I don’t have the ability to predict bottoms. What I do have is the ability to assess the core value of energy stocks, and that tells me the stock prices of many Canadian resource companies are significantly lower than they should be.
Tamarack Valley Energy (TVE) is one of many beaten down junior oil producers. A recent joint venture deal announced by Bellatrix Exploration on its Cardium acreage caught my attention, and made me think of Tamarack Valley. Here are the key points of the Bellatrix deal: Bellatrix’s partner (Grafton Energy) will contribute $100 million to the $122 – million joint venture, which will give it a 45 per cent working interest in 29 Notikewin/Fahler and Cardium wells. It’s a complicated transaction, but what matters for our purposes is that it works out to a valuation of approximately $3 million per well. Why does that matter for Tamarack Valley Energy? Because the Cardium happens to be one of the company’s two core plays.
Tamarack Valley has 45.3 Cardium well locations. At $3 million per well (the implied value in the Bellatrix joint venture) those 45.3 locations would be worth $135 million.
Tamarack Valley’s total current enterprise value (at $2.30 per share) is $110 million, which is less than what the Cardium assets alone might be worth. Considering Tamarack Valley has a significant amount of other assets in addition to the Cardium, it does appear that the current stock price is a bargain.
Now, there is a catch in these numbers. The Bellatrix joint venture involves not just Cardium wells but also Notikewin gas wells, and so we don’t know how many of the 29 wells in question relate to the Cardium and how many relate to the Notikewin. That’s why we can’t rely solely on those Bellatrix deal metrics to assess Tamarack Valley’s valuation. Good news, though: There are other metrics that paint the same picture. For 2013 Tamarack Valley expects to average 3,000 barrels per day of production, 56 per cent of which is oil and natural gas liquids. With an enterprise value of $110 million Tamarack is trading at $36,666 per flowing barrel.
Another Canadian producer (Whitecap Resources) just acquired 2,900 boe/day of production in the Valhalla and Garrington areas of Alberta, and it happens to have the exact same weighting to oil and liquids as Tamarack Valley’s production: 56 per cent. So, same volume, give or take a few barrels, and the same balance of oil and natural gas liquids. But same price? Nope. Whitecap paid $173 million for that 2,900 boe/day of production, which equates to $60,000 per flowing barrel. If Tamarack Valley’s production was similarly valued at $60,000 per flowing barrel the company would have a share price of $4.64 which is more than double where the shares currently sit.
It’s pretty clear that Tamarack Valley’s assets are undervalued, but it’s even more obvious – as any investor who’s looked at their portfolio statement lately understands – that in this market that’s not enough. As John Maynard Keynes once said, “markets can remain irrational a lot longer than you and I can remain solvent.” And so, a discounted valuation isn’t enough – investors also need to focus on companies with solid balance sheets and an ability to live within cash flows. Tamarack Valley seems to be able to do this.
In 2012 Tamarack Valley increased production per share by 70 per cent while also reducing debt. In 2013 the company expects to continue growing production with capital spending being fully funded from cash flow and existing working capital. The company does not need to tap the equity markets to grow.
Why? Its two core plays, the Cardium and the Viking, both recycle cash very quickly – usually in less than 18 months. This enables cash invested in every well to be paid back quickly and put to work again. A fast payout like this on cash invested in drilling wells is crucial for small producers today.
With cash flow in 2013 expected to be $30 million and net debt of $53 million (end of Q1) Tamarack has a reasonable debt to cash flow ratio of 1.7 times. Tamarack is a good company in a bad market. When that market turns, I expect Tamarack’s share price to move higher in a hurry.