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Why Renegade Petroleum might be due for a bounce

What goes down, might come back up

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

Nov 28, 2013

by Jody Chudley

If you’re an investor in small Canadian energy producers, chances are you own a few stocks with charts that looks like ski slopes – and they’re going the wrong way. This sector of the Canadian market has fallen out of favour, especially with American and European investors pulling capital from the area. Some companies with very low levels of debt and respected management teams have certainly been spared from the worst of the selloff. For others, though, the situation has gotten ugly.

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The most beaten-down stocks are of those companies that carry high levels of debt. There is opportunity amongst these more highly leveraged and disliked names, one example of which is Renegade Petroleum. Turn back the clock one year on Renegade Petroleum and you see a share price that was at nearly three dollars. Today, its shares need to triple to get
back to that level. And the company isn’t just a victim of an unhappy stock market, either. Much of what has happened has been self-inflicted.

The problems began for Renegade on October 29, 2012, when the company announced that it was making a transition from a “growth” model to an “income plus growth” model. The change involved acquiring 3,600 barrels per day of low decline (18 per cent) light oil production for $405 million. The low decline nature of these assets was to be a compliment to the growth prospects of Renegade’s Viking play and allow for the introduction of a dividend. This was a large transaction for Renegade, as it almost doubled the company’s production. To finance the acquisition, Renegade planned to issue equity and use debt.

When Renegade announced this deal, the company provided this guidance for 2013 with respect to debt levels: “Optimal leverage and ample liquidity with approximately $244 million of net debt on a bank line of $325 million representing net debt/2013E Cash Flow of 1.82x.” The market didn’t initially love this deal, but it didn’t hate it either. It wasn’t until March of 2013, when Renegade released its fourth-quarter 2012 results, that the stock price really fell apart. The balance sheet showed that, post-transaction, the company didn’t have $244 million of net debt as expected; it had $290 million. To make matters worse, Renegade’s cash flow was below expectations. Instead of having a reasonable debt-to-cash flow ratio of 1.82 times, Renegade’s had blown out to more than three times.

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The market reaction was understandable. Not only did Renegade have a much higher level of leverage than advertised, the company also clearly did not have a handle on this giant new acquisition. The numbers were way off from what had been guided. Renegade explained the higher than expected debt level was caused by much larger than anticipated closing adjustments on the acquired assets, but that didn’t provide shareholders any comfort. And adding to shareholders’ dismay, in July the company announced that the $0.23 per share annual dividend that had been established only a few months earlier was being reduced to $0.10 per share. After all this, Renegade’s management had little credibility left in the eyes of many shareholders and investors.

But is there opportunity in this mess? We all want to be like Warren Buffett and step in and buy shares of beaten-down companies when everyone else is terrified to own them. So is Renegade dirt cheap, or is the new one-dollar share price justified?

In my opinion, there is nothing wrong with Renegade’s assets. In fact, I love Renegade’s pure focus on light oil with very strong netbacks and great economics. Current production for Renegade is 95 per cent light oil, which is the highest I can find among companies of a similar size in Canada. Renegade operates in two core areas: the Williston Basin in southeast Saskatchewan and the Viking in southwest Saskatchewan. The Williston Basin is currently producing 5,000 barrels per day for Renegade and includes the property that was purchased in 2012. This is a conventional light oil play with lots of running room in terms of locations yet to be drilled. The Viking is a “resource play” that is being developed using horizontal drilling and multi-stage fracturing. Renegade is now producing more than 2,000 barrels per day from the Viking and has another 81 net drilling locations on 16 net sections of land.

At a share price of $1.08, Renegade has an enterprise value (includes net debt of $280 million) of $506 million. At the current share price, that means Renegade is trading at $67,000 per flowing barrel – and remember, it paid $405 million late last year for 3,600 barrels of that production, a deal that works out to $111,000 per flowing barrel. Today, those same barrels are being valued at 60 per cent of what they were purchased for less than a year ago. Yes, there’s still that mountain of debt, but the strategic review process that Renegade’s board has had underway since April 15, 2013, could change that. If it results in the sale of the entire company or one of Renegade’s core assets, investors who bought at current prices could be very happy. That’s why I think Renegade might be a good investment at current prices. What I’m sure of is that longtime Renegade shareholders wish the idea of converting into an income plus growth model had never seen the light of day.

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