Finding Growth in a Flat Energy Market: Tim Murray
Source: George Mack of
The Energy Report
Clean balance sheets, cash flow visibility and trading
liquidity in oily stocks are the cornerstones of investment
success in junior E&Ps, according to Oil and Gas Analyst Tim
Murray of Desjardins Securities. In this exclusive interview with
The Energy Report,
Murray lays out his risk/reward proposition for his very favorite
The Energy Report:
Tim, what is your investment thesis right now?
It hasn't changed since the last time we talked. We are biased
towards oil plays. But we will look at selective natural gas
players and we prefer the lowest-cost producers as well as the
companies with a larger production base.
Are you currently telling investors that they need to be
Yes. Most of the small/micro cap stories have seen a dramatic
drop in share price over the last year; however, WTI (West Texas
Intermediate) is hovering around $100/barrel (/bbl), and oil
companies should be able to generate strong cash flow at these
levels. The market has gone quieter on the smaller-cap companies
as investors traditionally flock to larger, more liquid names in
times of uncertainty. Once we see more general stability in the
global market place we expect money to once again flow back into
small/micro cap names.
So, how does a micro-cap company get out of a hole like this? If
its market cap has been knocked down so dramatically that the
stock becomes hard for mutual funds to own, what must happen to
get out of that situation?
It usually comes down to market sentiment changing. Money
managers will eventually start looking at the small caps again
because those companies offer significant potential gains in a
portfolio. You don't buy small caps or micro caps for 20%
returns; you buy them for 80% or 90% returns. Small cap names may
currently be light in many portfolios, however we believe market
participants will return to these names once general global
market stability is demonstrated. The other option is to become
an active acquirer in order to grow in size, however this can be
a challenging goal for many small caps that have depressed
valuations, unless you can purchase another small cap in the same
Do institutional E&P investors tend to think in terms of
value, or are they looking for growth names?
I think most institutional E&P investors are still looking
for growth prospects. However, many of the small cap names are
trading cheaply on a cash flow basis, so these growth stories can
also be viewed as value plays. Most institutions are choosing
companies with better balance sheets that don't have to go to the
market to raise money to move their drill programs forward.
Companies that can show good visible organic growth from cash
flow for the next two to three years seem to attract more
attention. Institutions also seem to be most interested in liquid
Gasoline prices in some regions have declined to the sub-$3/gal
range, and this is right in front of a big holiday. Are we
looking at continued weakness now in commodity oil?
I don't think so. We do like the commodity and prefer it to
natural gas right now. As for natural gas, we are bearish in the
short/medium term, and I don't see any meaningful near-term
catalyst to change that. We don't see $50/bbl oil in the near
term and we are thinking that anywhere between the $80-100/bbl
bandwidth is a realistic range for WTI to trade over the next 12
What catalysts are needed to turn energy stocks around?
Well, some equities have done well this year, and so it's hard to
paint a broad stroke across the board. We believe once general
market stability has returned that market participants will
return to the small/micro cap space. Looking more to a
company-specific level, management teams that continue to deliver
results will see stock prices that outperform their peers.
When could we see some upward movement?
There is lots of news flow operationally for the names I cover in
January and February, so positive drilling results should help
push individual stocks higher. On the commodity front it's really
hard to project what's going to unfold in the next month and we
prefer to look out over the next 12 months and believe a
realistic trading level is between $80-100.
What names are you talking to investors about today?
The ones I'm talking about the most have strong management teams,
good balance sheets, liquidity and visible cash-flow growth. My
favorite name is Whitecap Resources Inc. (WCP:TSX.V), which has
all those characteristics. Whitecap is run by Grant Fagerheim,
who has led several other successful junior oil and gas
companies. We believe Whitecap has a top-tier management team.
This is the biggest company that I follow in terms of production
and reserves, and it also has the best liquidity. It has a
visible light oil growth profile for the next several years,
offers a top-tier cash netback and a low relative corporate
decline, which we believe positions them very well. We also like
that Grant has traditionally been an active M&A player, which
we think leads itself well to the current environment as we have
mentioned previously many small/micro caps trade fairly
What's the story here? Is it about the Pembina Cardium and
Yes, and it is acquiring Compass Petroleum (CPO:TSX.V), which
will give the company another core area targeting the Viking in
the Dodsland region of Saskatchewan. So, it now has a fourth core
Your target price was $11. Have you upped that?
Yes, it's $12.25 now.
That represents 40% upside potential from here.
Yes, and the upside may seem light for a small cap, however it
carries considerably less risk than some of the other companies I
cover. For instance, I have a target of $1.25 on Torquay Oil
Corp. (TOC.A:TSX.V; TOC.B:TSX.V), which would be a much greater
return, but there's a lot more inherent risk in a Torquay then
there is with Whitecap. So, on a risk/return basis, Whitecap is
currently my top pick.
You took Torquay down from a $2- to a $1.25-target, which is
still better than a 200% implied return from current levels.
What's your investment thesis on the company?
A larger portion of my $1.25 target hinges on the company's key
core property at Lake Alma. The company is basically trading at
my base net asset value (
), which is essentially all the company's other properties.
Torquay has discovered oil at Lake Alma; however, it has not been
extracted economically to date. Torquay's management team
believes they do have a viable play and that they can extract the
oil economically. However, Torquay is not big enough in size to
fund a meaningful drilling program from cash flow, and the
company is going to have to go to the market to raise money if
they would like to get aggressive again with Lake Alma. The large
drop in share price and its marginal success at Lake Alma over
the last 18 months could make raising money challenging. That's
why on paper it looks like a no-brainer to invest in because of
the huge potential return, but there's a lot of risk associated
with the company from a market perspective (raising capital) and
exploration risk at Lake Alma. If Torquay can't succeed at Lake
Alma, then I would have to remove the Lake Alma upside of
Who is currently buying the stock? Is it the hedge fund
Since November and December, Torquay has had relatively huge
trading volume. Some investors picked it up in the $0.25-0.30
range because they thought it was so cheap that they couldn't go
wrong as it was trading below its base NAV. So they basically got
exposure to Lake Alma for free. It's hard to say who's playing in
this story right now. Some hedge funds may be looking to add this
classic high-risk/high-reward play to their portfolios.
What other companies do you like?
It is not my top pick, but one of my other favorite names is
Spartan Oil Corp. (STO:TSX). I think of it as a mini lookalike of
Whitecap, however smaller in size. Spartan's core property is
located at East Pembina targeting the Cardium formation.
Management is very familiar with the Cardium as its predecessor
company showed terrific growth drilling the Cardium horizontally.
The key asset for Spartan is the Keystone unit #2, which is a
legacy oil pool that has been drilled vertically. Spartan
believes it can substantially increase the recovery factors
through the application of horizontal drilling. The #2 unit has
never had a horizontal well drilled into the pool and Spartan has
drilled three to date, and we're waiting on results from these
wells. Spartan also has a couple of exploratory plays in
Saskatchewan, which is the torque in this story. Further positive
drilling results could lead to another core area. We also would
like to point out that the balance sheet is very strong and
Spartan could announce a very aggressive 2012 capital
This is the best-behaved stock in your universe. It's had its
head above water for an entire year.
Is your target still $4.75?
My target is higher than that. It's $5.25 now. Whitecap and
Spartan are my two favorite names right now. I like both their
balance sheets. I believe Whitecap can show organic growth in the
20% neighborhood from cash flow over the next several years, and
Spartan should be able to demonstrate similar numbers over the
next 12-18 months because its balance sheet is very strong.
Tim, you follow Strategic Oil & Gas Ltd. (SOG:TSX). I saw
that it had recently negotiated a $40M bought-equity deal. When a
company can avoid the risk of going to the market by selling its
equity directly to the investment banks, it sounds like a very
I definitely agree with that as Strategic will have a very strong
balance sheet entering 2012, which will allow it to have an
aggressive 2012 drilling program. Strategic has two oil plays
that are both very early stage and quite high risk. We can see
growth prospects for the next 12-18 months if either one of the
oil plays is deemed commercial. On a comparable basis,
Strategic's assets are much higher risk than Whitecap's or
Spartan's. This stock could perform very well with good drilling
results or very poorly with bad drilling results.
I enjoyed speaking with you very much. Thank you.
Cheers. Thank you.
Tim Murray joined Desjardins Securities in July 2011. Prior
to this, he was an oil and gas analyst for almost six years at
several investment boutiques covering junior and mid-cap
companies. He also spent over a year at AltaGas Income Trust
performing risk and credit analysis on natural gas and power
assets for the company's midstream business and served as an
investment advisor for three years. Tim was awarded the CFA
designation in 2003.
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1) George Mack of
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