Having good management is always important for any company. For a small oil and gas producer management is crucial. Successfully financing and growing a small oil and gas company is extremely difficult and loaded with risk.
I’ve learned the hard way that if I’m investing in a small oil and gas producer I have to be focusing only on companies with proven management teams.
Novus Energy has a proven management team.
Most of the Novus management team was part of the growth story of Gentry Resources Ltd., an oil-weighted exploration and production company, that over eight years grew from initial seed financing of $2.5 million ($0.22 per share) to $300 million ($4.19 per share) when it merged with Crew Energy Inc. in August 2008.
Production had increased more than 335% to 5,000 boe/d. That growth was reflected in an 818% increase in Gentry’s stock price and a compound annual return of 32%.
This team is led by CEO Hugh Ross and it appears that Novus is going to become Gentry Resources part 2.
Company history and business
Novus is a young company which started operations as a private company and then came public with a recapitalization of Regal Energy in the spring of 2009 at which time current management was brought in.
Management moved quickly to build up a large acreage position in 2009 and through 2010 in its core Viking play.
Novus has three main plays with the dominant one being the Dodsland Viking in Saskatchewan. Novus has an emerging Viking resource play located in Provost as well as some Cardium and Dunvegan lands in Wapiti.
The largest core area for Novus is located in the greater Dodsland area of Southwest Saskatchewan. This area is centered by Kindersley and ranges from Flaxcombe/Whiteside in the West; Prairiedale and Kerrobert in the North; and Plato and Forgan in the South and East.
Novus has focused on light Viking crude oil, which has depths of approximately 750 meters and can be found throughout the greater Dodsland area. Novus first ventured into the area in Oct. 2009 and has subsequently acquired additional lands from corporate acquisitions, asset purchases, farm-ins and land sales, resulting in the corporation controlling 124 net sections of land across the Dodsland area. In 2012 Novus operated the drilling of 72 (72.0 net) horizontal Viking oil wells, and the corporation now owns working interests varying from 5% to 100% in 262 producing wells.
Novus' share of production in 2012 was: 2,201 Bbls/d of light/medium oil; 2,334 Mcf/d of gas; and 1 Bbls/d of NGLs. The majority of the capital program for 2013 is allocated to the greater Dodsland area for the drilling of high working interest horizontal oil wells.
The Wembley property is located in northwest Alberta, approximately 3 kilometers northwest of Grande Prairie. Drilling targets are mainly oil at depths varying up to 2,200 meters. Novus owns a 100% working interest in three producing oil wells. Novus' share of production in 2012 was: 44 Bbls/d of oil; 137 Mcf/d of gas; and 12 Bbls/d of NGLs.
The Provost area is located in east central Alberta, and encompasses Novus' properties within the area from Twp 29 Rge 1 W4M in the southeast corner to Twp 38 Rge 20 W4M in the northwest corner. Drilling targets are mainly natural gas at depths varying up to 1,000 meters. Novus owns working interests varying from 1% to 100% in 39 producing wells. Novus' share of production during 2012 was: 555 Mcf/d of gas and 5 Bbls/d of NGLs.
The Viking Is A Perfect Resource Play For a Small Producer
The development of unconventional oil resource plays (shale and tight oil) is still relatively new business for the oil industry. What we have learned so far is that the resource plays that require expensive ($8 million plus wells) do not work well for the little producers.
What the little guys need in order to effectively develop a resource play is one with lower well costs and a quick payout of invested capital. The small players need to be able to recycle cash quickly. Big expensive wells don’t work and neither does investing capital in a well that pays back that investment slowly.
That is why the Dodsland Viking is a perfect resource play for Novus.
A typical well costs Novus only $930,000 and pays out in just over a year. These aren’t sexy wells as they produce at initial rates under 100 barrels per day, but they are very economic because the Viking zone is shallow and the well are inexpensive.
Ross and his management team have used a sensible amount of debt as Novus drills up the Viking. At the end of the first quarter of 2013 Novus had $83 million of net debt and cash flow of $16 million for the first quarter.
Annualizing that cash flow results in $64 million for the year and a debt to cash flow ratio of $83 million / $64 million = 1.3 times to 1.
That is a comfortable level of debt for a producer of this size.
Novus has $105 million of capacity on its credit line and with the reserve and cash flow increases accomplished in 2012 it is reasonable to assume that credit line could be increased.
Sometimes investing doesn’t have to be complicated, and making the case that Novus is undervalued is not difficult.
Step 1 - Calculate Enterprise Value
Share Price - $0.74
Fully Diluted Shares Outstanding – 212,000,000
Net debt - $83 million
Cash From Option Issuance - $18,100,000
Enterprise Value – (212,000,000 x $0.74) + $83,000,000 - $18,100,000 = $221,780,000
Step 2 – Assemble Reserve/Cash Flow/Production Details
Current Production – 4,085 boe per day (82% oil)
Total Proved Plus Probable Reserves – 22.72 million barrels (82% oil and NGLs)
PV10 (Pre-tax) of 2P Reserves - $377 million
2013 Q1 Annualized Funds Flow From Operations - $64 million
Step 3 - Calculate the Multiples of Production/Reserves/Cash Flow
Enterprise Value / Current Production - $222 mil / 4,085 = $54,291
Enterprise Value / Proved and Probable Barrels - $222 mil / 22.72 = $9.76
Enterprise Value / Pre-tax PV10 - $222 mil / $377 mil = .60 times
Enterprise Value / Q1 cash flow - $222 mil / $64 mil = 3.46 times
Enterprise Value / Q4 2012 forecast cash flow - $231mil / $65mil = 3.5 times
If you follow the Canadian energy sector I think you will recognize that these multiples are very attractive.
Check out the following transactions involving oil weighted production that have occurred over the past year:
- On Nov. 2, 2012, Equal Energy disposed of 525 barrels per day (93% oil) of production for $62 million. That is $118,000 per flowing barrel.
- On Feb. 16, 2012, Crescent Point Energy (CSCTF.PK) bought 2,900 barrels per day of oil production from Petrobakken for $427 million. That is $147,000 per flowing barrel.
- On June 1, 2012, Crescent Point closed on an acquisition of 2,500 barrels per day of oil production in the Shaunavon for $343 million. That is $137,200 per flowing barrel.
- On Nov. 1, 2012, Crescent Point Energy acquired 7,800 barrels per day (88% oil and liquids) of production for $861 million. That is $118,000 per flowing barrel.
- On Oct. 29, 2012, Renegade Petroleum acquired 3,600 barrels per day (94% oil) of production for $405 million. That is $112,500 per flowing barrel.
- On Dec. 10, 2012, Bonterra (BNEFF.PK) purchased Cardium focused Spartan Oil for $112,000 per flowing barrel.
This is not a cherry picked list of the highest valuations, this what oil weighted properties go for. Each one of these transactions is at least twice what Novus is currently being valued at.
The same would be true for valuations of transactions based on proved and probable reserves which generally occur at $20 per barrel or higher which is twice the current Novus valuation.
When you also consider those multiples in light of the rate that Novus is growing they are really interesting.
In 2012 production for Novus was up over 50% year-on-year and cash flow a similar amount. Being able to buy this kind of growth at a multiple under four is compelling.
Comparable Transaction - Long Run Exploration Disposition of Viking Assets
As I said, I think the attractiveness of the valuation here is blindingly obvious. But to make it even easier to see there is a recent transaction in the Viking right beside where Novus operates:
Long Run Exploration Ltd. ("Long Run" or the "Company") (WFREF.PK) is pleased to announce that it has signed a definitive purchase and sale agreement (the "Agreement") to sell certain non-core assets for total cash proceeds of approximately $180 million, before any closing adjustments.
The non-core assets include the Company's Viking interests located in the Plato / Dodsland / Lucky Hills areas of Saskatchewan. These assets are currently producing approximately 1,900 boe per day (1,800 barrels per day of crude oil and 600 mcf per day of natural gas, based on field estimates).
The proceeds of $180 million for 1,900 boe/day of production is $95,000 per flowing barrel.
Here is what happens if I apply the metrics from that sale price to Novus:
Estimate of value - $95,000 x 4,085 = $388 million
Less - net debt of $83 million
Add – Option and warrant proceeds $18 million
Market Cap - $388 million - $83 million + 18 million = $323 million
Diluted Shares Outstanding – 212 million
Estimate of value per share - $1.52
Current share price - $0.74
Again using a transaction on a neighbouring property makes Novus appear to be trading for half of what it should be.
Comparable Company - Raging River Valuation
Raging River (RRX):
Raging River is the Viking producer that Mr. Market seems to love for whatever reason. Raging River operates in the exact same Viking play that Novus does, yet has a much different valuation.
Here is how the market is valuing Raging River on a fully diluted basis:
Enterprise Value / Flowing Barrel (2012 exit rate) - $604 million/4,000 = $151,037 per flowing barrel (90% oil)
Enterprise Value / Cash Flow (Q4 2012 annualized) - $604 million/$60 million = 10.06 times
Enterprise Value / Proved Reserves (Dec 31, 2012) - $604 million/11.5 million barrels = $52.53 per barrel
Raging River is valued at two to three times what Novus is (at least). I think Raging River is fully valued and maybe a little more, but certainly suggests again that Novus is selling for half of what it should.
Value Realization Process
Undervalued is one thing. Undervalued with a near term catalyst is another.
Novus is currently in the middle of a “value realization” process which is code for the company being up for sale.
This process started in earnest in January 2013 and has dragged on longer than expected. The market has lost patience and is why the Novus stock price has dropped.
I believe if Novus gets a fair offer, the company is going to be sold.
Novus is a smallish commodity producer so there are obviously risks involved.
The number one risk is the price of oil. If oil goes down, the value of Novus goes down. The Viking is a high netback play so Novus will be better off than many companies, but the bottom line is that if you are investing in a commodity producer you had better have an opinion on the underlying commodity.
Risk number two is that Novus is a one trick pony. It is pretty much fully dependent on its primary Dodsland Viking resource play. If something funny happens with that play (flood, forest fire, production issues) Novus doesn’t have a backup plan.
Risk number three relates to the horrible state of the capital markets for small Canadian resource players. If Novus wants to go to the market for equity financing it is going to be horribly dilutive. Novus doesn’t need to go to the capital markets to continue growing, but not having that option does take some things off the table (such as company acquisitions using equity).
I took the time to write this value investing submission for Gurufocus.com for one reason. I think Novus has a very real chance of doubling in the next year.
Novus ticks pretty much all of the boxes on my checklist:
- Good management team
- Extremely cheap
- Excellent high netback resource play
- Good balance sheet
- A value realizing catalyst
I own this company and would buy more tomorrow. Of course I was saying that a year ago as well so buyer beware.