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TransGlobe Energy: Undervalued With Strong Growth Potential

May 10, 2014 | About:
Value Investor

Value Investor

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TransGlobe Energy Corporation (TGA) is an oil and gas exploration and production company with a market capitalization of $587 million and majority of its interest in the Arab Republic of Egypt with a small part of their operation in Yemen. Investors who are not risk averse should consider this small cap oil player in Middle East as an attractive investment opportunity. This article will discuss the revenue drivers and the risks associated with the company’s operations in Egypt.

Current Fundamentals

Before discussing about the company’s valuation and its operating activities, I would like to briefly touch on the company’s impressive financials. TransGlobe Energy has a robust operating margin of 27% and EBITDA margin of 35% as compared to peers. Just as an example, Devon Energy Corporation (DVN) has an operating margin of just 5.8% and Pioneer Natural Resources Co. (PXD) has a negative operating income for FY 2013. Higher operating and EBITDA margin indicates greater operating efficiency compared to peers.

The balance sheet also looks strong with a debt of only $87.5 million translating into a low Debt to EBITDA of 0.4. The company therefore has a strong financial flexibility, which is important for growth in the foreseeable future.

Vaue in $ millions for FY 2013

TransGlobe Energy

Pioneer Natural Resources

Devon Energy

Revenue

635.9

3489.5

10397

EBITDA

222.2

299.1

3401

EBITDA Margin

34.9%

8.6%

32.7%

Operating Income

173

-608

621

Operating margin

27.2%

NA

6.0%

FCF

70.3

-730.6

-1322

Debt

87.5

2653.1

12022

Debt/EBITDA

0.4

8.9

3.5

Besides the strong financials, what makes TransGlobe Energy an attractive investment is the fact that the share price of the company has not been in sync with the company’s revenue growth per share since the beginning of the Egypt crisis. The graph shows that there has been 194% growth in revenue per share of the company in contrast with a share price decline of 41%.

I am of the opinion that investors have avoided the stock considering the current situation in Egypt. However, the company’s ability to continue to increase their revenue year over year implies that the company has the intrinsic ability to survive the market conditions and outperform as the political scenario gradually improves in Egypt.

Attractive Valuations

Closely related to the above point, TransGlobe Energy is trading at attractive valuations amidst the depression in stock price due to political factors. The company is currently trading at EV/EBITDA of 2.5 and this is very cheap as compared to some peers. Pioneer Natural Resource is currently trading at an EV/EBITDA of 16.9 and Devon Energy is trading at an EV/EBITDA of 5.0. Further, the company’s EV/Revenue of 1.7 is also less than Pioneer’s EV/Revenue of 8.9 and Devon Energy’s EV/Revenue of 3.3. Both these valuation metrics point to gross undervaluation.

This undervaluation could be attributed to the company’s operation in Egypt, which is a high risk prone region. However, there has not been any negative impact on the company’s operation in Egypt even after the political crisis. On the contrary, the company has increased its production from 2011 to 2013 by a CAGR of 15%, with majority of the increase in Egypt. Therefore, the overall negative sentiments have depressed the stock at a time when the company continues to perform well.

Source: Company Presentation

Increasing Demand

Another important and positive factor for the company is the amount of unexplored resources in Egypt. Political unrest has resulted in very few companies operating in this region. TransGlobe Energy is one such company, which can exploit the resources to meet the increasing demand. The long-term growth potential is therefore significant.

TransGlobe Energy is already ramping-up production to meet the energy demand in the region. The company has estimated an increase in production rate to 20,000bopd in FY2014 and plans to double production to 40,000bopd within the next four years. A strong growth in production will translate into robust top-line and bottom-line growth for TransGlobe Energy over the next few years.

High Free Cash Flow An Added Advantage

TransGlobe is one of the few oil and gas Exploration Company with positive free cash flow, which is high enough to fund the company’s capital expenditure. The company plans to spend around $94 million in the exploration and development of wells in Egypt with only $6million capital expenditure in Yemen. This capital expenditure is projected to be fully funded by the company’s free cash flow. In addition to this, the company’s free cash flow also covers for the debt and hence TransGlobe Energy can practically pay back all of its debt in a year.

The following section would look at the projected free cash flow of the company and how this is sufficient to fund the company’s capital expenditure.

The company’s has a forecasted production of 20,000bopd and a planned capital expenditure of $100 million for FY2014. . I would make the following assumptions to calculate the projected free cash flow (2014E) of the company.

1) Price of oil at $100 per barrel

2) EBITDA margin of 35% (same as FY2013)

3) EBITDA cash conversion ratio of 90% (same as FY2013)

As per the above assumptions, estimated revenue for FY2014 would be $730 million, an increase of 15% over FY2013. Considering an EBITDA margin of 35%, the company’s EBITDA would be $255 million. Further, an EBITDA cash conversion ratio of 90% translates into an estimated operating cash flow of $229 million for FY2014. As mentioned earlier, the company plans a capital expenditure of $100 million in FY2014. Therefore, the free cash flow for FY2014 is likely to be $129 million and this also covers for the current debt of $87.5 million.

Conclusion

Considering the company’s current undervaluation and high net cash position I consider TransGlobe Energy as a lucrative investment. The upside potential is immense considering the valuation gap this stock has compared to peers. I would recommend this stock for investors with a relatively high risk appetite.

About the author:

Value Investor
A value investor.

Rating: 4.5/5 (2 votes)

Voters:

Comments

marketcash
Marketcash premium member - 6 months ago
I definitely agree with you,TGA is cheap at EV / EBITDA of 2 and forward P/E of less than 6. don't know were to find a cheaper company in this market today.
Dr. Paul Price
Dr. Paul Price premium member - 6 months ago

You said, " I would recommend this stock for investors with a relatively high risk appetite."

I'd say, "Nobody seeks out high risk as an attribute. Some investor s may tolerate high risk if they think they will make outsized returns."

***********************************************************************************************************

You never gave the current price of the stock anywhere in your article even as you spoke about many of the company's valuation ratios. Was that an oversight, or an attempt to avoid accountability for future price action?

Value Investor
Value Investor - 6 months ago

I am wondering if the share price point is an issue. The date of publishing the article will not change. One can always refer to the historical stock price (if needed).

kfh227
Kfh227 premium member - 6 months ago
For whatever reason, alot of energy comaonies are cehap these days. Maybe due to regulations that may come down the pipe regarding fracking.



I'm in 3 oil and NG stocks. I'm basically piggybacking Prem Watsa (Trades, Portfolio) for hte most part. PWE and SD are two of his holdings.



The thing is, this stocks doesn't look any cheaper than PWE and SD but I am more confident piggypacking Prem.

batbeer2
Batbeer2 premium member - 6 months ago

>> Was that an oversight, or an attempt to avoid accountability for future price action?

WOW!

That is an interesting comment in light of the fact that you delete your dumbest recommendations from this forum.

The purpose of this forum is not for keeping an audit trail. Authors are free to share their thoughts and delete or change them later if they feel it's appropriate. Some will and some won't. That's just my opinion though. You are welcome to disagree. However, by your actions, you have shown that you find it necessary to delete your (admittedly dumbest) ideas from the forum.

Why do you expect from others what you yourself are unable or at least unwilling to do?

http://www.gurufocus.com/forum/read.php?2,17975,page=1
Dr. Paul Price
Dr. Paul Price premium member - 6 months ago

Batbeer,

Your attack is unwarranted, refers to a comment dated in 2007, and is not worth responding to.

I have over 400 articles posted here on GuruFocus for all to see. People can make up their own minds as to my credibility. Can you be serious when you say this forum is not about accountibility with stock picks? People earn the title 'Investment Guru' by performing well over time. That can only come from measuring how their holdings do.Those who don't like their track records pubicized generally have poor results. Your own newsletter's actual record is impossible to verify performance-wise and is as transparent as mud. I have to assume that is intentional. Why don't you list your beginning of the year holdings after each 'rebalancing' and show how you are doing overall each month? You can follow all my equity and option writing buys and sell easily on MarketShadows.com. My portfolios are well ahead of all three major indices YTD and since inception.

batbeer2
Batbeer2 premium member - 6 months ago

>> Can you be serious when you say this forum is not about accountibility with stock picks?

I am. Again, that is just my opinion. You are entitled to yours. The problem is that you are imposing your opinion on other forum members/authors. That is just not very constructive.

>> People earn the title 'Investment Guru' by performing well over time.

No. Your opinion is not reality. There are many with a superior track record that are not considered gurus and there are some with poor track records that are.

>> Your own newsletter's actual record is impossible to verify performance-wise and is as transparent as mud.

You are welcome to your opinion. I do not write that newsletter to prove I'm smart.

Deleting your own posts seems inconsistent with your stated opinion that the forum is primarily for preserving a track record. I think it is better not to expect from others what you yourself can't or won't.
Belarophon
Belarophon - 6 months ago

Besides all the comment-deletion-issues between Dr. Price and Mr. Batbeer, this company looks quite interesting. It should be mentioned, that they'll soon be starting to pay a quarterly dividend.

HrZg
HrZg premium member - 6 months ago

I agree TGA is undervalued. I wrote about the company a few weeks ago at Gurufocus - http://goo.gl/fCWexQ - and since then the stock has pulled back about 15%. At these price levels, ithe company really is a bargain with a huge upside.

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