Seeking Alpha
Profile| Send Message|
( followers)  

Toward the end of 2012, three junior Canadian oil and natural gas producers officially announced their intention to initiate a three-way merger to form a brand new medium-sized corporation with a balanced mix of crude oil and natural gas production organized on the dividend model with a very high payout ratio. It turned out to be a very messy process despite what one Canadian oil and gas industry journalist I spoke with suspects had been in the negotiation and planning stages for a year or more, unbeknownst to the shareholders of Avenex (OTC:AVNDF), Charger, or Pace.

The problems arose when a small group of shareholders from the largest of the three companies (Pace Gas and Oil) initiated a proxy fight to prevent the merger in the run-up to two separate scheduled shareholder meetings. This delayed the planned merger and forced management to reassess their options and address the major criticisms being leveled against the proposal. After a good faith effort to find a better deal for Pace shareholders the vote was rescheduled for the third time on March 26, 2013, and the merger was approved by separate shareholder votes from all three companies, allowing for a consolidation of revenues, assets, debts, and credit lines into a single consolidated balance sheet. The merger allowed the new company to shed two highly paid executive management teams and significantly streamline operating costs enough to be able to allocate a significant portion of revenues toward paying down debt and funding a hedge program to protect against fluctuations in the prices of oil and gas and most importantly for shareholders to sustain a dividend, which is something Pace shareholders had never seen.

Spyglass Resources Corporation was born on March 26, 2013, and now trades on the Toronto Stock Exchange under SGL.TO as well as the OTC in the United States under the ticker OTCQX:SGLRF. With all the black eyes Spyglass has suffered fighting for its birth, along with it being a relatively unknown company that has been flying well below the radar, it has seen its share price decline to a level well below the current $3.00 price target given by industry analysts and is currently paying a dividend yield of a whopping 15% at its current $1.75 price per share which returns $0.022 per share per month. This artificially low price per share is despite the fact that the numbers do in fact indicate the dividend is safe and sustainable. Where Spyglass shines in this writer's opinion is not just in the dividend yield, but in the potential for capital gains. Trading at such a low price per share allows the retail investor to load up on a very large block they can hold onto and then patiently wait while collecting a 15% per year yield paid out on a monthly basis.

One source I have consulted reported that a CEO he spoke to went on record as saying that "the big money has exited the Canadian oil patch." He further goes on to clarify that "the big funds I met with confirmed they are less than 30% invested in the Canadian energy sector compared to the historical 85%." This certainly explains why numerous stocks in the Canadian oil sector are trading right now at fire sale prices, which in the case of a few companies has drastically increased their effective dividend yields. This same source also discusses in depth the risks inherent to investing in this sector at this time.

One of the more compelling reasons to own Spyglass is the past success of management. Tom Buchanan, Charger's former Chairman & Chief Executive Officer founded Founders Energy Ltd. in 1993 from an initial investment of only $700,000 and ultimately created $3.8 billion in value by 2012. Founders converted into Provident Energy Trust at 5,000 boed in 2001 and Provident then grew its upstream business to a peak rate of 35,000 boed. The upstream business was eventually divested and the remaining mid-stream business was sold to Pembina Pipeline Corp. for $3.8 billion.

Tom Buchanan architected Provident Energy Trust: its upstream growth, its midstream business development, its conversion to a dividend paying corporation and the ultimate divestiture of the upstream business. At the time of the wind-up of the upstream business, Mr. Buchanan decided to leave Provident to start another junior oil and gas E&P - Charger Energy Corp. in October 2010.

Several members of current management of Spyglass were together at Founders Energy Ltd. Kelly Cowan, Mark Walker, Mike Shaikh round out Buchanan's team.

The Alberta Viking formation is following the same pattern of evolution as the Bakken & Viking formations did in Saskatchewan eight and five years ago respectively; fragmented land ownership, successful drilling experimentation, development then corporate consolidation. Spyglass has an appreciable land position in the hot technologically renewed Viking formation in Alberta and investors can therefore enter this play very cheaply, at its formative stages.

I find myself asking how much longer it will be before retail investors in the market find these lucrative high yield opportunities. Or will they ignore them and let big money back in first at a much lower PPS than when they left? It is certain that the media in the United States is not going to tell Americans about this opportunity and the Canadian retail investor market is simply not large enough to fill the void left open by the institutions and mutual funds. The few articles that do seem to get written about these Canadian stocks always have the following header: "NOT FOR DISTRIBUTION TO U.S. NEWSWIRE SERVICES OR FOR DISSEMINATION IN THE UNITED STATES. ANY FAILURE TO COMPLY WITH THIS RESTRICTION MAY CONSTITUTE A VIOLATION OF U.S. SECURITIES LAWS."

The company-specific risks are of course always a matter of concern. As with any dividend stock the one event that results in a general crash is the reduction or wholesale suspension of the dividend itself. Management does in fact make their dividend announcements on a monthly basis, so there is always the risk that with little or no warning investors might find themselves with a diminished or vanishing dividend stream along with a commensurate drop in the per share value. It is always necessary to do your own due diligence and have an understanding of the economic data derived from a company's financials to best gauge its ability to live up to its forward looking statements. One should always take a close look under the hood before investing in any stock.

Some Fundamentals

  • P+P reserves, 93.3M
  • Drilling locations 1000+
  • Total shares outstanding 129M
  • Tax pools 900M
  • Net debt 293M
  • PACE Assets 582M (Plus Avenex and Charger )
  • Line of credit 400M (+107M)
  • 2013 average production 16,000
  • Capx program 70-80M
  • Cash flow 104M
  • Dividends 26M
  • Payout ratio 25% to 30% of cash flow

What I and other investors have determined by all of this is that Spyglass is grossly oversold. The NAV value of Spyglass's producing reserves should be around $2.40. If you value in the total reserves of 93.3M, the 900 million in tax pools, the net debt, the low decline rate of wells, and the breathing room afforded by the line of credit, Spyglass was oversold at $2.40 and even from there the PPS still has a long way to grow. 2013 exit production guidance is at 18,000 boe, with a producing reserve value around $4.00 - $4.50.

The fundamentals are already there for Spyglass shares to rise in value year after year just due to the low decline production rates and the leverage it has to drill light oil in Southern Alberta and Provost, and the premium low risk properties in the Viking fields.

Some say the problem is debt, but there are bigger problems than debt in the Canadian oil sector. Spyglass has every problem covered and already has enough revenues to maintain the debt while paying it down along with an active hedging program to maintain those revenues even if oil and gas prices fall. A long-term sustainable dividend easily fits within the budgetary framework. The problems oil companies face are tax pools, quality assets (light oil), decline rates, and producing reserves. Spyglass has them all covered and is further hedged in the market with half of its production in natural gas so it is able to shift production to whichever commodity is commanding the best price, or simply divide their focus in half to hedge their profit margins one against the other as prices of both commodities very often increase and decrease opposite one another.

For a detailed presentation please see this Spyglass Resources Corp Presentation.

Note: As of submission the stock price has bounced slightly to ~$1.89. This is further evidence that the stock found support at $1.74, and with a tight stop in case it breaks down to new lows, this remains an attractive entry point with a favorable risk reward profile.

Edited by Michael LaRocca: michaeledits@michaeledits.com.

Source: Spyglass Resources Corp: An Undervalued, High-Yield Dividend Performer