Harvest Natural Resources Inc. -- HNR
HNR is an oil and gas company whose only producing properties are in Venezuela. They have a very good track record both in terms or their relationship with the government and as an oil/gas producer. Also, their management team is pretty shareholder friendly. According to Yahoo! Finance, HNR’s Corporate Governance Quotient (CGQ) is better than 96.5% of Russell 2000 companies and better than 94.7% of energy companies.
Last year they (and other foreign oil companies) had to cease drilling operations and amend their operating contract so that they would have a minority (40%) interest in their oil projects. In addition to that, HNR was given 3 additional fields to develop which has made their “conversion process” take longer. The conversion process is now in its final stage and should be completed very soon. Instead of filling everyone in on more background info, I’ll get straight to valuation.
PER BARREL VALUATION
Recently PetroFalcon (PTC.TO) purchased a minority oil interest in Venezuela called Lundin Venezuela. Per their press releases they are making the purchase via issuance of 64M shares and 5M warrants. The share issuance alone is US $49M. The warrants will increase that #, but I haven’t priced them so I’ll just be conservative and call it $49M. The purchase includes $27M in cash on the balance sheet, leaving a price of $22M for Lundin Venezuela’s reserves, which is 3.05mmboe. $22M/3.05mmboe = a purchase price of $7.21 per barrel of oil. (The price per barrel will actually be somewhat higher after factoring in the price of the warrants).
HNR has $136M in cash on their balance sheet. They have 150mmboe. Their market cap is $463M. So $463M - $136M = $327M for their reserves. $327M divided by 150mmboe = only $2.18 per barrel of oil equivalent. So, as you can see, HNR is trading for way less than a very recent deal price. If we just assume that HNR can sell their reserves (i.e. the Venezuelan operations) for $6 per barrel – a reasonable assumption – then HNR is worth $27.26 per share (150mmboe x $6 per barrel plus $136 cash divided by 38M shares outstanding). HNR also owns a property in the South China Sea that is the subject of a dispute between China and Vietnam. It is adjacent to a huge Exxon property and if the dispute gets resolved in HNRs favor, it could be worth a lot to HNR shareholders. However, I have not given it any value in my calculations.
PRESENT VALUE OF RESERVES
In 1992, when HNR began to develop 3 fields (called the Monagas fields), proven reserves were just 18M barrels and HNR has produced over 124M barrels from those fields since that time. They have done a great job of getting oil out of the ground. Their historical recovery rate is 27%. Last year HNR had Ryder Scott, a well-respected independent petroleum engineering firm, prepare a reserve report. The report shows that, using a conservative 13% recovery rate assumption, the PV10 of HNRs reserves = about $24 per share. My understanding is that if HNR can match their historical recovery rate, the PV10 of their reserves will more than double to over $48 per share.
When viewing the present value of their reserves in light of their history recovery rate, I believe HNR is a good buy at twice the price. At $12 and change it looks like a steal to me. The only explanation I can come up with is that the price is being held down because there is lots of “headline risk” and political risk. The other foreign oil interests have already completed the conversion process, and after HNR does things should be back to “business as usual.”
1.) President Chavez signs the transfer decree and drilling begins. There is not a single example of President Chavez disallowing a conversion. The new contract is under his country's terms, and HNR has a good long-standing relationship with the Venezuelan government. I'm really not sure why anyone would question this event.
2.) The PV 10 of HNRs reserves, net to HNR, are worth about $24 per share with a conservative 13% recovery rate assumption. If HNR just matches their historical recovery rate of 27%, I think the present value of those reserves will more than double. Any improvement in recovery rates over the next couple of years should send this stock way higher.
3.) HNR diversifies into another country, as planned. I believe this is just a matter of time. Management has indicated their intention to diversify into other countries on a number of occassions in the past year or so.
4.) A buyout of HNRs Venezuelan operations by another oil company. This will likely be done at a very large premium to today's price.
5.) The dispute between Vietnam and China gets resolved, and HNRs WAB-21 property in the South China Sea is developed. It is adjacent to a large Exxon property and would be extremely valuable upon resolution of the China/Vietname dispute.
6.) After the conversion process is complete, HNRs financials will be restated retroactively to show solid profits. Since they haven’t had a formal contract with the Venezuelan government since April 2006, they haven’t been able to show their oil/gas revenues and earnings per GAAP accounting rules. Analysts will begin to upgrade HNR and institutional buyers will become more interested in the stock.
There are 6 possibilities, at least 2 or 3 of which are extremely likely to occur. Any one of them occurring should result in a stock price way higher than today's $12 price tag.
Here are some links that provide other interesting commentary on HNR: