Lightstream (OTCPK:LSTMF) announced its third-quarter 2013 production with the following highlights:
- Production was 45,100 BOEPD, weighted 78% to light oil and liquids. This was above the consensus expectations of 44,753 and represented a 17% increase over the same quarter last year.
- The company is finalizing operational plans, working toward its goal of a sustainability ratio of 100% and debt to cash flow below 2.0.
The company was hit with a slew of analyst downgrades and target cuts the next morning. Seven analysts now rate the company at "hold," and one at "buy." As I discussed in a previous article, the analysts' recommendations fly in the face of their own numbers. Their average price target is $9.21--37% higher than the current price. Even if the dividend were cut in half, that suggests a 44% total return. Even the lowest new target suggests a 25% return. Despite this, the negative ratings changes combined with what I believe is a misinterpretation of the press release, knocked shares down 8% on a day when the S&P 500 advanced nearly 2%.
So how did investors and analysts misinterpret the press release? They pounced on the higher percentage of dry gas production. The reality is the dry gas proportion increased by less than 2%. Moreover, there was an extra 1000 BOEPD (70% light oil) that was not produced because of processing infrastructure. That production will be brought online in the future and more than compensates for a slightly higher gas mix. Overall, production is inline with the company's projections and the company still expects to exit the year with production of 47,000 BOEPD or more.
Investors and analysts also disliked this statement:
We. . . remain committed to improving our sustainability ratio (cash outflows compared to cash inflows), lowering our debt to cash flow ratio and improving our liquidity through the many options available to us, which include, but are not limited to, modulating capital expenditures, selling assets, terming-out debt, altering our dividend program or issuing equity.
The company has included similar language in recent MD&As, so this isn't really news. But analysts and shareholders were concerned about the company issuing equity. With shares yielding 14.2%, that sounds like a particularly ill-advised option. To check on this, I talked to a company official today, who noted that options are listed in order of priority and likelihood. The company was simply providing a completely exhaustive list of all the possibilities, with the dividend cut being less likely and an equity issuance being an extremely unlikely possibility-- just ahead of selling the office furniture.
As I noted in the previous article, selling the company's Duvernay acreage by itself could resolve the company's debt problem. This is underscored by the fact that the recent results from Trilogy (OTCPK:TETZF) and others have made the Duvernay a hot play. So I expect to see asset sales in the near future.
It's worth noting that a year ago, the company was actually producing less oil and had more debt, but was trading at twice the current price. The decline is mostly about the psychology of a possible dividend cut. This is irrational. Apparently some investors believe that paying out a higher dividend makes the company more valuable, regardless of whether the cash flow supports it.
The reality is, the company's value is determined by its assets and its income. A dividend cut would not change the assets and it would increase the income. Personally, I would prefer a smaller dividend that leaves a cash buffer to invest with the company's lucrative 1.8 recycle ratio. Note that other companies in this sector, like Enerplus (ERF) and Penn West (PWE) actually saw their share prices jump dramatically after they cut their dividends.
Whatever the reason for Lightstream's massive price drop, it has made the stock's valuation even more compelling than before:
Enterprise Value/flowing barrel
I believe that analysts used the recent production report as an excuse to lower their ratings on a stock that has underperformed recently. Nobody wants to have maintained a big "buy" rating on a stock that has dropped 50% in a year. The market over-reacted to these downgrades and to the perception that a dividend cut is imminent. A possible dividend cut is nearly as poor a reason to sell as the ratings downgrades. A cut was already priced into the stock months ago, when it was first suggested. In any case, if the dividend is not truly unsupported by cash flow, a cut is positive for the underlying value, not negative.
I believe that Lightstream can reduce its debt and provide a high, sustainable dividend by selling a few assets. However, I am guessing it may never come to that. With Warren Buffett buying into Suncor (SU) and Carl Icahn buying into Talisman (TLM), it is clear that the Canadian E&P sector is ripe for acquisitions. No other intermediate or major oil producer with $50 netbacks trades anywhere near Lightstream's $63,000/flowing BOE or its $14/BOE reserves valuation. With management seemingly incapable of bringing this value to shareholders, I expect that someone else will come along and do it for them.
Additional disclosure: I am also long LTS.TO shares traded on the Canadian TMX exchange.