Gear Energy, Raging River Exploration: Exchange With A Fund Manager

The following is a conversation between a fund manager and me regarding Gear Energy and Raging River Exploration. This fund manager wishes understandably to remain anonymous.

Both of us make interesting points on recent developments regarding Gear and Raging River. Here is the conversation.

Fund Manager: I was reading your recent Raging River article and I noticed you mentioned Gear was selling their Duvernay land position. I own a bunch of Gear and talk to Ingram every couple months and I didn’t even know they had any Duvernay!

I have a few questions for you about it. Why do you think they’d sell it instead of hold it or drill it? And how do you come to your estimate of C$15M to C$20M of value for it?

I’m kicking myself for not knowing about this and grateful for you uncovering it and writing about it.

I’m thinking about Raging River, but I haven’t even finished your article yet, so I’ll hold off asking about your take on it. I know a bunch of their competitors thought the stock was overvalued considering the high base decline rate.

Cadotte Capital Partners: I didn’t know either… Not until I searched for Gear and Duvernay.

I figured with under 7,000 acres you don’t really have the scale to develop a meaningful new growth play. Gear can already drill for light oil in Central Alberta. In all, better to sell it, especially with big operators near the acreage (Raging River and Vesta). Both could be very interested to add to their land position.

I obtained a total value of C$14M using a valuation of C$2,000 per acre. This number could be way too bullish in retrospect… Raging River values its Duvernay position at C$400 per acre. The bidding deadline is tomorrow. We’ll see soon enough.

FM: Well, 7,000 net acres could be a huge number of locations, and it looks like Gear is in or near one of the cores of the play. Vesta is ramping up drilling big time and Raging River is just to the north and the combined company will likely drill more up there too. I get why Gear would sell it, but if it were me I’d hold it or maybe even drill one well and see what I have.

I don’t think you’re off in terms of what they should be able to get for it. I should probably be bidding on it, below C$10M, unless there’s near term lease expiries or something, I’d buy it! And I’m a little worried because the obvious bidders, besides Vesta, are Raging River and Crescent Point Energy. Raging River is otherwise occupied, and Crescent Point just got new management and the executive who was responsible for the East Duvernay play left.

Also, I noticed in some of your articles you’re referencing the Montney offer as a dollar per acre comparison metric. I think liquids rich Montney is apples and oranges with Duvernay. Not guiding higher or lower on either of those, other than my thoughts on adjacent-to-core East Duvernay land value above. There are also specifics of land positions that can dramatically alter their dollar per acre value metrics.

The Raging River and Baytex Energy merger is thought provoking. I’m tempted to start buying Raging River given the large drop in share price and the arbitrage with Baytex. But… Raging River wasn’t cheap: Valued at about 4X PDP, high decline rate, rapidly burning through inventory, waterflood apparently isn’t working because the decline rate doesn’t seem to be falling, and finally the fact that its doing this deal means that this was the best deal they could find, which is troubling. It could probably mean their East Duvernay play isn’t working how they hoped. I guess the question is how much does the share price needs to fall for a higher bidder to come along or for the combined company to be cheap enough to offer enough upside to buy.

CCP: Yeah, drilling one well… Gear might as well concentrate on its own assets. As I say: Go big or go home. And those wells aren’t cheap either…

Gear is tiny compared to its neighbors. Could be one of the reasons Neil Roszell wanted to get bigger: He knew he would need to have size to develop Raging River’s massive acreage.

The high decline rate, the high valuation of flowing barrels: I see a lot of people claiming Raging River wasn’t trading cheaply. I disagree. The consensus EPS is C$0.62 in 2018 and C$0.76 per share in 2019. Of course I don’t have access to the models of the analysts so these numbers are to be taken with a grain of salt. But at first sight it seems like Raging River is trading at under 10X earnings.

And free cash flow was just around the corner. Higher oil prices will increase free cash flow exponentially. Yes, the decline rate is high. But I believe it all depends on earnings. If a high decline rate is met with low drilling costs, or higher oil recovery, or anything that increases earnings, then in the end, even though the oil flowing out is depleting quickly, you’ll still be making money. My thoughts anyway.

As for the waterflood, I can’t find anything mentioning the results aren’t encouraging. All the latest presentations (January, February and March 2018) pointed to a possible recovery factor of 25%. The recovery factor I usually see for waterflood is 20%.

It’s troubling Raging River couldn’t find a better alternative… Clearly I overestimated the sentiment in the Canadian oil patch. It isn’t bullish for Granite Oil, another small company I own. It also started a “review of strategic alternatives”.

I slowly bought some more shares of Raging River. I was barely in the red. Turns out my entry point wasn’t so bad after all.

The low end of my price range was C$7.25 per share: Upside is about 20% upside from current levels.

Probably the only good news in the short term is that Neil Roszell will become Chairman of the new company. Hope he really takes a very active role and improve governance. No need to tell you Baytex could use a little bit of that…

FM: Interesting. Thanks for sharing your thoughts.

CCM: Sure thing!

Disclosure: I am long GXE, RRX. Not for republication on Seeking Alpha.

Raging River: Endure The Pain

  • Raging River agreed to merge with Baytex for a small premium. After today’s selloff, the market is saying both are better at it alone.
  • Raging River is worth somewhere between C$7.25 and C$10.00 per share.
  • Baytex was trading at C$5.10 last Friday, which would value Raging River at C$6.94 per share, which is in the low end of the price range above.
  • Investing in Raging River is now like investing in Baytex: It’s a leveraged play to future oil prices.

Click here to read the entire article on Seeking Alpha.

Portfolio Update: Adding To My Energy Holdings

Last Wednesday was a test for energy investors. Did you resist the urge of following the masses by selling your energy holdings?

I resisted. I added to my favorite energy holdings last Wednesday, which are Gear Energy, Point Loma Resources and Raging River Exploration. Those companies can survive low oil prices and then thrive once oil prices rise.

Here are my recent moves in the market.

First, I sold all the lithium explorers I bought last month: Critical Elements, Nemaska Lithium and Natan Resources, now Enforcer Gold. I was lucky to turn out a profit on this: Critical Elements skyrocketed 50% after investors learned the company had hired a communication firm for a year.

This experience would be cash neutral at best if it wasn’t for this gain. Just for example: Enforcer Gold switched its focus to gold exploration after I bought the stock for its lithium properties. All in all, this is another point to not speculate on the market.

Second, I sold TransGlobe Energy. It turns out the Canadian assets aren’t as transformative as I thought they would be. I first estimated netbacks at C$11.50 per barrel for total consideration of 6X 2017 FFO. Instead, netbacks were as low as C$6 per barrel in Q4, which implies an estimated price tag of over 10X 2017 FFO.

The Cardium light oil acreage should provide interesting returns according to past presentations from Angle Energy. Management will drill these lands only in late 2017. Therefore it will take some time before shareholders see something good from these assets.

I sold what was left of my position in MEG Energy for a sub-50% gain. WTI at sub-$50 won’t be enough for MEG to sell its pipeline at a good price. Hence share price appreciation will be limited in the short-term.

I added massively to my positions in Point Loma Resources, Gear Energy and Raging River Exploration using these gains.

I bought back Tidewater Midstream and Infrastructure on Friday after selling the stock two weeks ago. Support was limited below the 200-day moving average.

TWM StockCharts.com March 13

Source: StockCharts.com

Low AECO prices in Western Canada may delay growth projects by producers and lower flows in pipelines owned by TWM in the short-term.

I am now heavily positioned in the oil and gas sector with a strong presence in junior Canadian E&Ps with low leverage and high netbacks. Those companies can survive at $50 WTI and thrive at higher prices.

Disclosure: I am long GXE, PLX, RRX, TWM. Not for republication on Seeking Alpha.

Choosing An Unlevered Canadian Energy E&P

I raised cash after selling part of my Amaya position (I bought back some, as I said on StockTwits). To let you know: I already spent that cash on Gear Energy last week. My quick calculations were right: Gear Energy is cheap.

I will be looking for a solid balance sheet just in case the rout in oil prices continues. As you know, I already own MEG Energy, a leveraged E&P company. One is enough.

I made a basic stock screening of Canadian oil E&P companies (75% or more liquids production) with low debt (total debt on equity needs to be under 30%).

Unleveraged Oil E&P - TSX Screening

TSX TickersNet debt (C$M)EV (C$M)FFO (C$M)Net debt/FFOEV/FFO
WCP7954,6584231.911.0
RRX1002,2561970.511.4
SPE481,048760.613.9
CJ23647530.412.1
GXO29184211.48.9
GXE34178251.97.5

Source: Corporate Presentations, Cadotte Capital Partners

I already own Raging River Exploration. I will include the company in today’s comparison nonetheless. I have been handsomely rewarded by holding on Raging River Exploration, let’s try and repeat that.

As you know, I need an unlevered company. Gear Energy is an unlevered company in disguise for three major reasons:

First, 38% of Gear Energy’s debt is convertible to equity. The extra dilution from these convertible debentures is included in the EV/CF ratio.

Second, Gear Energy’s cost profile will improve. Indeed, the company purchased Striker Energy, a light oil producer in Western Alberta. This will increase corporate netbacks by over 25%.

Finally, Gear Energy plans to increase production by 10% next year while holding debt steady.

The additional cash flow and decreasing leverage warrant a higher EV/CF ratio. Furthermore, Gear Energy’s transformation is complete after multiple dilutive equity placements.

The company took care of its balance sheet and bought a light oil producer to diversify its production away from heavy oil. It also has an incredible board member in Neil Roszell (CEO of Raging River Exploration), which I know well.

I will update the table above with estimated numbers for next year. I believe the picture will be even clearer.

In conclusion: I’ll buy the dips.

Disclosure: I am long GXE. Not for republication on Seeking Alpha.