TransGlobe Energy Corporation (NASDAQ: 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 (NYSE: DVN) has an operating margin of just 5.8% and Pioneer Natural Resources Co. (NYSE: 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.
