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TransGlobe Energy: Peter Lynch-Style Fast Grower

April 29, 2014 | About:

Hrvoje Muhek

3 followers

TransGlobe Energy (TGA)

General profile

  • Stock price: $7.86 (as of Apr 29 close)
  • 52 week range: $5.52 – 9.66
  • Size: Small cap – $586 MIL
  • Industry: Oil exploration and production
  • Institutionally owned: 38%
  • Short interest: 0.26% of float
  • Dividend yield: n/a (future dividend announced)
  • P/E ratio: 12.15
  • P/BV ratio: 1.2

Business Description

TransGlobe Energy Corporation (TGA) is engaged in the exploration, development and production of oil and gas properties. It operates in two segments, the Arab Republic of Egypt and the Republic of Yemen. The company holds interests in eight production sharing concessions (PSCs) that cover approximately 800,000 net acres located in Egypt; and four PSCs in Yemen. As of Dec. 31, 2013, its total proved reserves were 31.6 million barrels of oil (MMBbl); and proved plus probable reserves were 45.3 MMBbl. TransGlobe Energy Corporation was founded in 1968 and is headquartered in Calgary, Canada.

Key Industry Risks

  • Oil price volatility: Profitability and returns depend on oil prices which are determined by global supply and demand.
  • Political instability in countries rich with oil: Wars and civil unrest can result in unexpected oil price volatility and in extreme cases the government may decide to expropriate foreign owned assets.
  • Major penalties as a result of environmental accidents.

Key Company Risks

97% percent of TGA’s revenues is generated in Egypt and the remaining 3% is generated in Yemen. Furthermore, a high percentage of revenues is generated by selling oil to the Egyptian government. If the Egyptian government does not honor its agreements with TransGlobe, the company would be significantly impaired.

Leverage and liquidity

Debt to equity ratio of 0.18x, Interest coverage ratio of 15.6x, and current ratio of 7.3x indicate a very healthy balance sheet. (Source: Capital IQ)

Why is the company undervalued?

It is undervalued because of civil unrest and political instability in Egypt during 2012 and 2013, where company generates 97% of its revenues and holds 77% of its assets.

Business Quality

Revenue Growth – revenue CAGR over the past 10 years is an impressive 25.86% with some year-over-year volatility. (Source: CapitalIQ)

Gross Margins – gross margins are volatile as a result of volatility in oil prices and volatility in commodities which act as inputs in production. (Source: CapitalIQ)

Return on Capital – return on capital has been historically at a very high level between 15% and 30%. Only once in 10 years ROC fell below 10%. (Source: CapitalIQ)

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Growth in Normalized EPS – past 10 year CAGR of normalized EPS is an outstanding 25.09%. (Source: CapitalIQ)

Economic Moat

The company doesn’t enjoy a sustainable economic moat. Its has an experienced and stable management and strong operational execution. Majority of management has been with the company for five years or longer.

Valuation

  • P/BV 1.2x - TGA is on the lower end of its 10 year P/BV range and is significantly below the S&P 500 Oil and Gas Production and Exploration benchmark of 2.0x. (Source: CapitalIQ)

  • P/E - 12.15x - TGA is on the lower end of its 10 year P/E range and is significantly below the S&P 500 Oil and Gas Production and Exploration benchmark of 22x. (Source: CapitalIQ)

  • Earnings yield (LTM EBIT / TEV) 25.78% - very few companies can be bought at such high earnings yield. Unlike most of the companies with a pessimistc market valuation, TransGlobe is not in distress; in fact, analysts expect positive forward earnings growth. (Source: CapitalIQ)
  • Forward PEG 0.38 - Analyst estimates for the next three years include diluted EPS growth of 45.80%, 21.40%, and 29.60% (2014, 2015, 2016) which translate into a CAGR of 31.87%. Current P/E of 12.15 divided by 31.87 implies a Forward PEG ratio of 0.38. If such high growth rates can indeed be achieved, the company can be bought at a bargain now. (Source: CapitalIQ)

Comparable Companies

Company name Ticker Market cap TEV / EBIT P / BV P/E Normalized
Bankers Petroleum TSX: BNK $1.33 BIL 8.2x 2.4x 13.8x
Pacific Rubiales Energy Corp TSX: PRE $5.13 BIL 8.2x 1.3x 9.8x
Gran Tierra Energy AMEX: GTE $2.02 BIL 5.6x 1.4x 10.9x
Average 7.33x 1.7x 11.50x
TransGlobe Energy NAS: TGA $0.59 BIL 3.9x 1.2x 7.2x
Discount to peers % 46.8% 29.4% 37.4%
Price target $11.54 $10.17 $10.80

Potential Catalysts

  • Gradual dispersion of uncertainty in Egypt – frequency of bad press from Egypt has been decreasing since the second half of 2013
  • Acquisition by another company – at current valuation levels TransGlobe is an attracive acquisition target. There was an attempt of acquisition by Caracal Energy in Q1 of 2014; however, the transaction was canceled as Caracal was acquired by Glencore Xstrata.
  • Continuing to post strong earnings growth despite market bearishness. Eventually the market should realize that multiples assigned to TransGlobe are not in tune with the fundamentals.

Conclusion

TransGlobe Energy is a quality small cap company with a proven ability to grow profitably at a very fast rate. At the moment the market is pessimistic about the company due to recent political turmoil in Egypt where the company is heavily exposed. TGA is trading at a heavy discount comparing to its past valuation (P/BV and P/E near 10 year lows) and comparing to its industry and peers (+30%). While concerns are justified, the current price level provides a good buying opportunity for Peter Lynch and Joel Greenblatt type investors.

Disclosure: I am long TGA.


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