Lone Pine Resources (LPR) is a small cap Canadian oil and gas producer trading at about $1. After LPR's IPO in May 2011 and subsequent spin-off from Forest Oil (FST), LPR shares traded down and never looked back. With the stock left for dead on balance sheet fears, any positives could push LPR up to between $2 and $3 per share this year. Multiple catalysts are on the horizon, with already closed asset sales providing ample liquidity, balance sheet repair and importantly plenty of time to execute a value maximization process.
The key to the LPR investment case is that the company has sold nearly $100 million in assets and repaid bank debt, which greatly reduces risks to the company's senior bank lenders. Bank debt/EBITDA was reduced from an uncomfortable 3.0x to more acceptable 1.8x. Happy bank lenders mean LPR has much greater financial flexibility.
LPR Stock is a call option: little downside but a lot of upside
A review of LPR's capital structure shows how leveraged the equity is to a recovery in the company's growth prospects. Equity investors are mostly afraid of leveraged balance sheets, but I see it as an opportunity, as long as the situation is stable and the asset base is as good as it is here.
With 4.2x debt/ebitda and 1.2x equity/ebitda, an expansion of just 1x in the EV/EBITDA multiple results in a near doubling of the share price. An asset sale that creates just $50 million in value, would increase the share price by nearly 50%. On the downside, with plenty of room from the banks, oil production hedges, and the bonds maturing in 2017, LPR has plenty of time. LPR is in effect an At The Money call option, but it is trading as if it is an Out of The Money call option. The misplaced fear of financial leverage creates attractive risk reward for an equity holder.
Enterprise Value Breakdown ($ millions)
- 155 Bank Debt
- 200 Long Term Bonds
- 355 Total Debt
- 104 Market Capitalization
- 459 Enterprise Value
- Bank Debt/'13 EBITDA consensus =155/85 = 1.8x
- Total Debt/'13 EBITDA consensus = 4.2x
- EV/'13 EBITDA consensus = 5.4x
Key catalysts on the horizon include further natural gas asset sales, an Evi oil Joint Venture or field level capital raise, proceeds from a $250 million lawsuit against Quebec. LPR has a surprisingly large collection of assets for a company with only $104 million in market cap. A comprehensive asset sale review is underway with an investment bank.
With significant natural gas resource in the Liard Basin, think Apache (APA) and Chevron (CVX) LNG project, as well as 6 TCF of resource potential in the Deep Basin of Alberta, Canada. This massive natural gas resource was interesting enough to allow LPR to IPO at an eye popping $13/share.
Who knows when natural gas prices will recover, but investors with a nose for attractive risk reward know that resource has not gone away and note that the Evi Slave Point light sweet crude oil development alone provides at least $3 to $4 per share of value to shareholders. Most analysts conservatively place LPR's NAV at between $7 and $9 per share. I don't give any credit for natural gas resource, so I think $3 to $4 is a fair near term target.
LPR holds 81,535 net acres producing over 3,200 bpd of light sweet crude here, the key is that Evi does not suffer from the painfully wide crude differentials of heavier Canadian crude grades. A review of last quarter's 10-Q shows that the company realized $80/bbl for their crude, relative to a WTI NYMEX price of about $90/bbl during the quarter. This compares to the woeful $50 to $60 per bbl heavy oil realizations that producers like Devon Energy (DVN) realized in 3Q 2012.
If it is so great how did LPR get all the way down to a dollar, you might ask? Too much debt, natural gas leverage and a slow start switching to oil drilling led to multiple disappointments on quarterly conference calls. 2013 EBITDA estimates were as high as $300 million during 2011 and have bottomed out at $85 million in 2013. As oil drilling picks up, look for those estimates to start rising.
The lows in LPR were made at the very end of 2012 as hopeless investors realized that LPR was unlikely to return to the $13/share IPO price and sold to take tax losses. The stock has perked up after the tax loss selling and seems to be finding some sponsorship as Northwoods Capital Management recently filed with a 5.28% stake in January 2013.
Technically LPR is set up very well as shareholders who were going to sell had ample reason to do so in 2012 as the tax loss incentive was quite strong and the shares seemed hopeless after multiple quarterly disasters. In fact the incentive to sell was so strong that as the company reported a better than consensus quarter and a well priced asset sale, the strong rally in the stock was overwhelmed with tax loss selling. That tax loss selling is behind LPR, with upcoming catalysts LPR is poised to rally strongly.