WMA Cara Report for week ending September 15, 2017
  • September 18, 2017 12:31 pm
  • by Bill Cara

Two Energy Names Worth Picking Up At Cycle Lows.

 

This week, we want to look under the covers of a couple of our holdings in the energy sector. One is Baytex Energy (NYSE and TSX:BTE) and MEG Energy (TSX:MEG and OTC:MEGEF).

 

MEG Energy

MEG is an established Western Canada oil sands pure-play investment that has:

  1. already invested the capex to locate and develop its massive 3.0 billion proven and probable reserves of what is known as heavy oil, the type often used to refine into expensive chemical products
  2. proprietary ownership of a specialized stem-assisted gravity drainage (SAGD) technology for low cost extraction of bitumen from oil sands and treatment, and
  3. managed to reduce net operating costs substantially to C$7.42/bbl and have lowered non-energy operating costs from C$9.00/bbl in 2013 to C$4.71/bbl in 2017 and G&A Expense from C$7.54/bbl to C$3.28 in 2017, and these expenditures are projected to be even lower going forward.

MEG’s corporate officers are widely known to have a wealth of oil and gas industry experience and their technology is exceptional. Management targets an average of 80,000-82,000 boepd (barrels of oil equivalent per day) production for 2017 with a current cash-flow break-even at US$45.02 WTI price.

At $55 WTI, management expects earnings to grow by +30%-50%. With the recent indication of higher prices and greater operating efficiencies, analysts have been raising revenue and earnings estimates.

Market capitalization is C$1.54 Billion with a Price to Book Value of only 0.41x. With the debt however, the Enterprise Value is C$6.20 Billion and gives a rich EV/Revenue of 2.85x.

The significant debt (approx. C$4.65 bil) with the low projected revenues (C$2.17 bil) has been a definite concern to the marketplace, especially as WTI prices were falling, leading to corporate losses. However, management cut costs substantially and they represent that the debt is quite manageable. Recently about the debt refinancing, they stated: “Debt refinancing retains covenant-lite structure, extends weighted-average life of debt maturity from 4 to >6 years with minimal increase in interest cost”.

But our key point is that MEG is mostly an oil reserve re-valuation play as the price of Oil increases over the next year or two to US$60, 65, 70 and higher per bbl – just as the market was giving values a continuously finer haircut as Oil prices were falling during the 2014-2015 period.

During 2014-2015, the WTI price fell very quickly from over $100 down through 90, 80, 60, 50, to bottom out in the low 30’s. During the 1Q2015, a time when WTI was averaging today’s 48-50 range, the market had been pricing MEG at about C$20.50. Today, at the same WTI price range, the MEG price is just 25% of the average in 1Q2015, now down close to C$5.00.

 

Due to the impact of price controlling computer algorithms, the market has it wrong. We say that because MEG’s bankers are extending further credit lines at this time because they know that earnings will recover under the OPEC-non-OPEC agreement for production cuts that will continue through the demand-supply rebalancing period. The bankers also know that cash-flow should easily cover the interest charges, and their analysts are valuing the energy reserves at much higher valuations than has occurred with today’s bearish market sentiment.

The institutional backing of the common shares is solid. Deep-pocketed private equity fund Warburg Pincus (12.8%), China National Offshore Oil Co (CNOOC) (9.8%) and Caisse de dépôt et placement du Québec (6.5%) own a collective 28% of the stock.

We are still a bit underwater with our holding of MEG, but we happen to be patient long-term value investors. We believe the 4Q2017 period will bring our position into profitability and that our upside through 2018 will be considerable.

 

Baytex Energy

Like MEG, Baytex is also an oil reserve re-valuation play should the price of Oil increase over the next year or so to US$60, 65, 70 and higher per bbl. Like MEG, BTE’s market cap suffered a continuously finer haircut as Oil prices plunged during the 2014-2015 period.

BTE

During 2014-2015, as the WTI price dropped from over $100 into the low 30’s, there was a lengthy period — the 1Q2015 — as WTI was averaging today’s 48-50 range, the market priced BTE at about C$20.00. Today, at the same WTI price range, the BTE price is just 15% of the average in 1Q2015, now just above C$3.00.

 

So, this price controlling algo we complain that is interfering in our capital markets has re-priced BTE almost the same as MEG under comparable energy pricing conditions. Yet, these are fundamentally unique companies.

BTE is half oil sands (heavy) oil and half Eagle Ford shale oil. What happened to the positive media coverage to the positive Eagle Ford shale play? We guess BTE just missed the boat.

We are still underwater with our BTE position as well. But, again, we are patient long-term oriented value investors who believe that Energy prices are on the rise and that the share price will soon reflect our fundamentals based belief, with significant gains ahead.

Baytex Energy Corp. is an established oil and gas corporation based in Calgary, Alberta that acquires, develops and produces mostly (79%) crude oil and natural gas liquids. Production is almost split 50:50 between the Western Canadian Sedimentary Basin (both heavy and light oil) and the Eagle Ford light oil in the U.S.

The Company is very well managed. Management is delivering on all commitments as expressed in the message to shareholders in the last annual report.

Production for 2017 will be 69,000-70,000 boepd. Revenue for 2017 and 2018 is projected to be C$955 mil and C$891 mil respectively, with a small projected loss each year. Debt is about C$1.81 mil, giving an Enterprise Value of C$2.62 bil. The EV/Revenue ratio is a rich 2.75x but the Price to Book Value is just 0.44%.

Financial liquidity is not an issue although, like for MEG, the market has been led to believe it is.

Like MEG, analyst consensus is for tremendous price appreciation potential. And like MEG, the vast reserves, when re-valued at say 60, 70 and higher WTI prices, will serve to push the share price much higher.

 

OTHER CONSIDERATIONS

At the end of the day, we believe the public will come to understand the reality of today’s capital market, one that is under the control of computer algorithms that are owned and operated by Humongous Bank & Broker (HB&B) and their central bank controllers at the Fed, Bank of England and ECB.

The evidence is obvious to anyone who wants to study the daily House trading reports from the Toronto Exchange. All Houses have a name and a House number, whether it be TD Bank, Canaccord, Morgan Stanley, Goldman, whatever. But, one doesn’t. House 01 is Anonymous.

When prices in an instrument are rising, House 01 is at the top with the most Buys, and when prices drop, 01 is at the bottom. The volumes are typically 50% of total volume for the day so that for the almost hundred other Houses, except for CIBC, RBC and a couple other big Canadian banks, their individual volumes are usually minuscule. What strikes you immediately is that for 01 only, the average price of the daily Buys is almost identical to the average Sells. This is wash trading as shares are only being circulated to make the rest of us think it’s a real market we are trading. Just as bad as the algo misleading the real investor and tricking the speculator into chasing non-real prices, the Toronto Exchange is paying for this laughable, so-called liquidity.

Some will recall our saying that “Books will be written” in response to the fraud that was apparent in 2006 regarding the cycle top of the US real estate market, pushed to ridiculous heights by the CNBC US Real Estate Tour of major cities that sucked in speculators and imprudent buyers. We believe that the same will happen in response to these computer algorithms – after the market crashes once again.

Wall Street must sooner or later accept the reality that as agents and advisors they serve the owners of capital. However, when central banks and HB&B develop systems that control prices, we no longer have a free capital market, one that is a price discovery mechanism that can be used by the public. At some point, the public will walk away.

There really is substance to the saying “Fool me once, shame on you. Fool me twice, shame on me.” The public can only be duped of so much of their wealth before they quit the system.

The public will see that the market system is working again after prices for stocks like MEG and BTE get back in sync with the primary drivers: WTI and Brent prices, central bank rates and commercial lending rates, and macroeconomic strength and the trends and cycles of these, as well as corporate earnings and revenues and asset valuations close to what are used by bank lending officers and private equity investors. If Wall Street prices are out of sync with all of this, we have no market that any of us can call real.

In any case, the more you apply investment tools and logic and the longer your time horizon and patience to wait for anomalies to revert to the norm, the more likely you are to achieve the results you desire.

 


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