GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Harvest Natural Resources Inc. -- HNR

October 03, 2007 | About:
equityguy

equityguy

0 followers
Here is my take on HNR. If it is anything like my usual analysis, it is full of holes and errors, so do your own due diligence and reach your own conclusions.

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.”


Catalysts include:

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:

http://valuevista.blogspot.com/2007/06/hnr-is-oil-gas-company.html

http://www.valueinvestorsclub.com/value2/guests/view-thread.asp?delay=90&id=2762&more=dtrue

http://boards.fool.com/Message.asp?mid=25532103&sort=whole#25534524

http://hcmthoughts.blogspot.com/2007_06_01_archive.html


Thoughts?

Rating: 4.1/5 (37 votes)

Comments

tkervin
Tkervin - 7 years ago
My cost basis for HNR is in the mid 9's. I think that the possiblity of Chavez not signing is remote but the result of that remote possibilty would be catastrophic. That is the drag. The transfer decree, was to my knowledge, to be signed last month. No word yet. While this could easily be a mid $20's stock I only based my purchase on $18 target within 12 months. Thank you for the excellent analysis. There has been similar work done on the Yahoo board, that came to conclusions on par with yours, but the level of garbage there is simply beyond belief. This for me is my one speculative position. Keeps the blood flowing......:-)
equityguy
Equityguy - 7 years ago
The transfer decree never had a specific date that it was expected to be signed. Lots of people were hoping for last month, but the actual date that it gets signed is pure speculation. Keep in mind that HNR just signed their contract less than a month ago, so it isn't like this last step (the signing of the transfer decree) has been dragging out for several months.

I've posted a little on the Yahoo! board but, like you said, it is pretty rediculous over there. I don't recommend anyone waste their time reading it.
tkervin
Tkervin - 7 years ago
I took the liberty of reposting equityguy's analysis on Yahoo. It received a couple of worthwhile comments.

http://messages.finance.yahoo.com/Stocks_%28A_to_Z%29/Stocks_H/threadview?m=tm&bn=2428&tid=58969&mid=58969&tof=1&frt=1
ndl11
Ndl11 - 7 years ago
While I agree with you this company is a"buy" in the sense that it has limited downside risk but could easily double. However I note the following:

1)The China -Viet Nam dispute border dispute has been around for 25 years and I see nothing in the press about them even talking about reolving the dispure

2)The Chavez risk will be around as long as he is and the market will discount HNR accordingly. I do not think he is stupid and he knows he needs foreign oil companies. He will sign the conversion deal. However when conditions deteriorate in years to come will Chavez go back to the "well" (PUN INTENDED!) and seek further money from HNR in the form of a confiscation of their property or higher taxes? The market will always give HNR a discount for this possibility

3) Venezuala owes HNR something like $80 million dollars for oil it used during the conversion process. Are we so confident they are going to get it?

Again I agree HNR has alot of reserves and is selling at such a substantial discount that it is a "buy" but the Chavez risk with the $80 million and a couple years out when Venezuala is really in economic trouble is fairly substantial!
ndl11
Ndl11 - 7 years ago
Other positives include Mohnish Pabrai has a big stake and there has been a large stock buyback.
JJINVEST
JJINVEST premium member - 7 years ago
my cost basis is $10.2 and made it my largest position at 13.5%. so for me, no need to add more. I am content just sitting on it. actually, in the last couple months, many of my other positions have appreciated while HNR stays put. so it is becoming a smaller part of my portfolio.

i would put restating of it earnings right up there in the catalyst list. i would not even consider vietnam/China dispute to be a catalyst; it is just a very remote chance. company's presentations on their website already made it clear so cheap the company is. that's why I bought it a couple months ago. their website very informative.
equityguy
Equityguy - 7 years ago
Here's the link to a follow-up post I made regarding HNRs earnings power:

http://www.gurufocus.com/forum/read.php?5,14464

Some people who read this post may not be aware of the other, so I figured it would be helpful to provide a link.
oilruler109
Oilruler109 - 7 years ago
$90 oil, and Harvest is trading BELOW $15 is shameful and criminal. With the company buying back at the very least 25 million worth of stock of the proposed 50 mil buy back (they have probably completed that by now) along with Mohnish owning 16% of the stock, both combined tally's up to 30% of the outstanding shares.

Doesnt add up. Stock with where oil is at; the pending decree due anyday along with both company and MP owning roughly 30% of the stock, no way Harvest should even be trading at these levels.....
John Krantz
John Krantz - 7 years ago
ndl11 Wrote:

-------------------------------------------------------

> Other positives include Mohnish Pabrai has a big

> stake


Now you know the price will go up in the near term as all Gurufocus members immediately start buying.

I kid, I kid.

Somewhat

equityguy
Equityguy - 6 years ago
President Chavez just approved the transfer decree and HNR now has permission to begin drilling again and restate their financials retroactively. I imagine that analyst coverage will begin again in the next few months. This event has reduced a substantial amount of the political risk in this investment. Should be interesting to see where the price goes over the next couple of quarters.
praxis
Praxis - 6 years ago
i've just looked on edgar and harvest site. there's nothing about the transfer decree approval
expectingrain
Expectingrain - 6 years ago
I just saw this on tradethenews.com. This stock really should be at 16-18 I think.
viksingh01
Viksingh01 - 5 years ago
Orinico fields are going up for auction, in vicinity of HNR's existing oilfields. Time to put that cash and Venezuala knowledge/connections to use.

http://www.ogj.com/display_article/343549/7/ARTCL/none/none/Venezuela-to-offer-up-three-Orinoco-blocks/?dcmp=OGJ.Daily.Update

gembree
Gembree - 5 years ago
Thought this was worth dredging up - HNR has gone from $7 to $4 since the last comment, and more importantly, enterprise value is somewhere around $0.40 a share. They have cut back production to abide by Venezuela's OPEC quota and delayed planned development. Can't be sure that they will continue buying back stock, but given they were buying it at $10, it seems likely.
DaveinHackensack
DaveinHackensack - 5 years ago
There's another oil stock that's been mentioned on this small cap board that has held up a little better -- partly because its assets aren't in Venezuela.
Amit Chokshi
Amit Chokshi - 5 years ago
ouch
Max7777
Max7777 premium member - 5 years ago
What we know: They have cut back production because of Venezuela's OPEC quota, this quota will probably not go much higher in 2009 due to bad economy and lower oil prices worldwide that OPEC wants to keep a floor under, so we can assume that HNR will have to stay on lower production capacity for this entire year, and suffer the revenue consequences.

If Mohnish Pabrai started selling his shares because he wants to diversify away from this situation or because some investors redemption's on his hedge fund, what will happen, he has a huge stack and it could put huge downward pressure if he sells it.

If Harvest itself stopped the buyback what would happen?

Is this a nice story and write up with wrong assumptions, huge uncalculated risks, and therefore wrong conclusions or is the market wrong and this is an unbelievable deal?

Following rule number 1, at this point I would vote for wrong assumptions and conclusions.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK