In late January 2013, I wrote an article about Surge Energy (OTCPK:ZPTAF), an oil-weighted intermediate producer with operations in Canada and US. It was when the price dropped below $4. Actually, I recommended Surge Energy back then at $3.7, for the reasons mentioned here.
I know that I am the only contributor of SA who writes articles about Surge Energy, but I do not really care. I always enjoy unearthing overlooked and grossly undervalued companies. This is how I discovered C&C Energia (CZE.TO) from the main Toronto board, recommending it at $5.7 in August 2012. My article is here.
Rock Energy is at $1.3 today, and its annual report confirmed my bullish call. I have been alone in that bullish call once again.
Back In January 2013
Returning back to Surge Energy, the concerns at the bottom of my first article focused on the following three things:
1) The CEO left to undertake routine health tests with an unknown date of return.
3) Few others estimated that the company's long term debt ratio was high although the D/CF (annualized) ratio was 2.2x as of December 2012, based on the company's funds from operations in Q4 2012.
Few Months Later
Several things have improved since then, and all the "concerns" above have been addressed, thanks to the company's updated information. Well, let's see what the company has done during the last three months:
1) The CEO returned back and resumed regular duties in early February 2013, after his short term medical leave.
2) The company received regulatory approval and resumed its drilling operations in the southern pool area of Valhalla in Q1 2013. The results from the first well of the Doig pool will show up in Q2 2013. This well was originally scheduled to be drilled during the fourth quarter of 2012 and was delayed.
3) In 2013, the company forecasts to achieve greater than 15% growth in funds from operations, bringing the D/CF ratio (annualized) at or even below 2.
Actually, what strikes me is the fact that there are many other oil-weighted companies in North America, carrying much higher D/CF ratios than Surge. Despite this, the market does not care about their factual debt issues, and eventually these companies trade at a significant premium in comparison to Surge Energy. To prove this, let's check out the following companies:
A) Halcon Resources (HK) is a US-based oil-weighted producer. I was bearish on Halcon at $8 when I shorted it, for the reasons mentioned here. I also noted then that the traders and the speculators pushed Halcon to an outrageous overvaluation at $8.
The company reported mediocre annual results few weeks later, and the stock dropped down to almost $6, confirming my bearish call. Even the company's highly touted Tuscaloosa Shale showed disappointing results and non-commercial production.
I closed my short position at $6.5, because I felt that the new wave of momentum traders and speculators was about to jump on board for the new ride after the severe correction of 22%.
I was right, because the stock has risen to $7.5 since then without any fundamental change. Apparently, the new wave of traders and speculators truly arrived at ~$6.5, where I closed my short position.
Halcon produced 18,348 boepd (81% oil and liquids) in Q4 2012, and it had 108.8 MMboe proved reserves as of December 2012. With Enterprise Value (EV) at $5.5 billion currently (including the recent additional debt), Halcon trades at $300,000 per flowing barrel, $50.5/boe of proved reserves and PBV=2.
Who cares for Halcon's D/CF ratio (annualized) which is as high as 6.5x?
B) Kodiak Oil (KOG) an one-basin energy play, lacking any land diversification. Kodiak operates solely at the Williston basin. Although the company's D/CF ratio (annualized) is 2.75x, Kodiak trades at $155,700/boepd and $34.8/boe of proved reserves, based on its current EV of $3.3 billion and production of 21,190 boepd (80% oil and liquids).
C) Oasis Petroleum (OAS) is another one-basin energy play that is solely dependent on the Williston basin. Although the company's D/CF ratio (annualized) is 2.73x, Oasis trades at $152,400/boepd and $29.31/boe of proved reserves, based on its current EV of $4.2 billion and production of 27,556 boepd (89% oil).
Additional Facts About Surge Energy
1) The insiders were buying a lot of shares even when the stock was hovering at $5.5 in late 2012. The thing is that the insiders kept adding on their positions when the stock dropped below $4, as evidenced here.
2) The new independent reserves report showed that Surge increased proved plus probable reserves by 43% to 46.1 MMboe (69% oil and liquids) over December 31, 2011 reserves of 32.2 MMboe.
4) New exploration success and exceptional drilling results came out from one of the company's core areas. Surge announced significant new pool additions and pool extensions at three of its primary operating properties.
For instance, the company's well at the northern part of the light oil pool extension at Valhalla hit IP-30= 1570 boepd (80% oil and liquids), and it was producing 356 boepd after 8 months being on production.
5) Surge has significant waterflood progress with waterflood projects in Silver Lake, Windfall, Waskada and Nipisi underway or planned for early 2013.
6) Surge also announced that the company's bank line was increased from $250 million to $290 million late in the fourth quarter of 2012, providing flexibility to execute the company's 2013 capital program.
7) With this 2013 budget, Surge expects to achieve greater than 15% growth in average production per share and funds from operations per share while maintaining its balance sheet. Based on Surge's 2013 guidance, the company is forecasting growth in funds from operation per basic share of more than 235% since the company was recapitalized in 2010 with a compound annual growth rate of 50% over that time. Surge is forecasting growth in production per basic share of more than 70% since 2010 with a compound annual growth rate of 20% over that time.
The Stock Is Deaf
Nevertheless, the share price has not listened to any of all these factual improvements thus far, but it remains around $3.
After all, Surge trades well below its book value (PBV=0.6) with EV at $430 million. The company produces approximately 10,000 boepd (73% oil and liquids) currently, and eventually it trades at $43,000/boepd and $9.33/boe of 2P reserves.
It is clear that these key metrics match the metrics of a heavily natural gas weighted company that also carries significant debt. To prove this, let's check out Comstock Resources (CRK). Comstock sold some assets recently to Rosetta Resources (ROSE) to reduce its long term debt which still remains high though.
Pro forma this disposition, Comstock produces 37,000 boepd (88% natural gas) and has 91.9 MMboe proved reserves currently. It is clear that the company is heavily natural gas weighted, and Comstock's D/CF ratio (annualized) is as high as 4x. However, Comstock trades at ~$34,000/boepd and $13.6/boe of proved reserves, based on its current EV of $1.25 billion.
I remain bullish on Surge Energy, and I added recently to average down. I believe that the market will recognize the company's value sooner or later. If not, Surge's value will be recognized by one of the majors that operate at the company's core areas. The M&A activity in the energy sector was never dead, and the bargains were grabbed with significant premiums.