You may be new to TransGlobe Energy Corp. (TGA), the Calgary-based exploration and development company with the focus of its operations in Egypt and secondarily Yemen. Listed on the Toronto Stock Exchange as TGL, this oil and gas operator presents investors a clear example of a potentially very bright earnings outlook coupled with geopolitical uncertainty, a classic conundrum of risk vs. reward. If you have been following the fortunes of TGA, and have read previously published articles by Seeking Alpha contributors, we believe you may benefit from reconsidering the stock in light of developments as recent as the past week. Herein we provide an update on some significant events in the company's theater of operations.
We do not own shares in the company at this time, although we have in the past. We are still bullishly inclined toward the company and may very well buy back in again. We find the stock to be undervalued at this time (as of Jan. 8, 2014), and believe the apparent risks are just that -- more illusory than real. Still, we would certainly acknowledge that every investor should pick his or her own poison, and this stock proposition may not be suitable for everyone. With those boilerplate statements and our predisposition on the table, we will endeavor here to re-examine the possibilities and the challenges.
The first metric that captures our attention is that the stock is currently trading at 7.17 times its projected 2014 earnings (9.72x TTM, diluted). Compare these numbers with the P/E of 21.65 (trailing 12 months) for the Nasdaq 100 as of Jan. 3, and 18.58x its forward 12 months (from Birinyi Associates, courtesy of The Wall Street Journal). Such a disparity immediately raises the question: "Why?" Why does the market currently value the dollars earned by TGA at a discount of 50%? Or, more aptly put, why is it so widely discounting the probability of future earnings?
The answer for many is all too obvious: Egypt and Yemen have been hotbeds of political and religious turmoil, and anti-Western sentiment now for seemingly forever. Yet, is that much discount really justified by the facts? To wit, one does need to attenuate the threat of recent developments involving the present governments of Egypt and Israel. On Jan. 6, JewishWorldReview.com reported that on Jan. 5 the Egyptians notified Israel they are terminating their relationship as natural gas supplier. This is somewhat concerning, since by the 1979 peace accord between the countries Egypt was contractually obligated to sell oil to Israel, and it did so for a couple of decades. However, Egypt's capacity to fulfill the deal diminished, and later a provision requiring Egypt to sell gas was added to the treaty. In 2005, the countries entered into an agreement that called for the Egyptians to provide 7 billion cubic meters of gas to Israel for 20 years, with the possibility of doubling that supply.
The importance of such a disruption to TransGlobe is unknown, but its effect on Israel is clearly recognized. Israel, having relied on Egypt for roughly 40% of its natural gas usage, will be seriously impacted if the parties are unable to come to a new agreement. Over the past year, the new Egyptian government has experienced difficulties protecting its transmission pipeline through the Sinai Peninsula from "Bedouin groups," but it claims to be cracking down on those responsible for the attacks. Still, the Israelis are unhappy with Egyptian security efforts.
For their part, the state's Egyptian Natural Gas Holding Company said on Al Jazeera TV the reason for the shutoff is that Israel is months behind on payments for the gas. However, the existing deal for gas sales has long been unpopular in Egypt. Protesters have decried it as an unfair deal entered into by former President Hosni Mubarak, whom they claim corruptly profited from the same. Some voices in Egypt say the deal needs to be renegotiated, while some voices in Israel are saying that Egypt's breach of contract is leading to war.
To be sure, there is unrest in the situation and should warfare break out, undoubtedly TransGlobe Energy could be negatively affected. Investors who are considering a purchase of TGA should look at the opportunity with a long term-view, and may take some consolation in realizing that there have been tensions between the two countries for centuries. In fact, both sides have much to gain from once again coming to a peaceful settlement.
As for TransGlobe, the company has been in Egypt since 2004, and has a successful operating history there. In their most recent quarterly report (Q3 2013), they showed comparative daily production in barrels of oil as follows:
|Country||3 Mo end 9/30/13||3 Mo end 9/30/12||9 Mo end 9/30/13||9 Mo end 9/30/12|
More encouraging Q3 developments included the drilling of 11 wells, which made 10 oil wells and one gas/condensate well. With regard to the Egyptian government, the company reported collecting $40.8 million in accounts receivable from the new interim government, which has been in place since July. Seemingly, the company has thus far been shown respect in the country by at least the new interim government. Indeed, a positive attitude toward other foreign O&G companies appears to have been underlined on Dec. 23 when the chairman of state-run Egyptian General Petroleum Corporation (EGPC) stated, "Today we are reimbursing $1 billion to the foreign partners and the rest during this week." Fourth-quarter payments to TransGlobe from this capital pool are unknown at this writing, but on Dec. 25 Egypt was reported to have made a $53 million payment for receivables due to Dana Gas, the sixth-largest gas producer in the country.
It's clear that Cairo is attempting to encourage exploration through faster debt repayments. Since the Mohammed Morsi government began in 2011, the country has been struggling to meet its financial obligations. On Nov. 7, 2013, TransGlobe Energy Corp. was finally awarded four new concessions in Egypt, which it had won in the 2011/2012 Egyptian General Petroleum Corporation's bid process. These Production Sharing Agreements (PSCs) doubled TransGlobe's concessions to a total of eight and their exploration acreage increased by nearly 800,000 acres to approximately 1.3 million net acres. TransGlobe has stated, "The recent approval of the new concession agreements by the Egyptian Government is viewed as a very positive indication that the current administration is focused on developing Egypt's resources as part of the overall economic recovery."
We think it noteworthy to mention that in the company's 2013 Q3 interim report they further stated that during the overthrow of the Morsi government, and subsequent demonstrations by his supporters, TransGlobe's Cairo offices and staff were "not materially impacted." Their guidance in the report called for continued challenges to their capital investment plans for the country for the medium range outlook "as Egypt works through its current macro-economic challenges. This has and will continue to impact our ability to execute our programs with the same predictability that we have historically experienced in Egypt."
On Dec. 9, a TransGlobe press release provided 2014 guidance and a mid-quarter update for Q4 2013. In this communication they reported collecting $253.4 million year to date from EGPC, and that they were in discussions with the government to collect additional payments before year's end 2013. The company forecast total collections for 2013 would be at least $270 million, or a 72% increase over their 2012 collections.
Highlights from the 2014 guidance provided include:
- 2014 production of 20,000 to 21,000 barrels of oil per day
- Funds flow of $146 million, or $1.93 per share
- 2014 capital expenditures to include $94 million in Egypt, $6 million in Yemen
- Exploration investments of $32 million, development of $68 million (a 22% increase over their forecast for 2013)
- 51 new wells to be drilled (46 net)
Finally, we should mention that within the Q3 2013 report the company postured itself as being financially strong and capable of rewarding shareholders in new ways in 2014:
The Company has determined that it is now in a position to achieve its growth objectives and simultaneously return some cash value to its shareholders. As such, the Company is undertaking to determine the most efficient and fair manner to achieve this objective. The Company is analyzing the possibility of beginning either a modest dividend program or a share buy-back program, or a combination of both strategies. The Company anticipates that it will determine which approach it will take in the near term and implement such approach in 2014.
Although financial statements more recent than Dec. 31, 2012, are unavailable as of this writing, what can be gleaned from that annual report, and by "reading between the lines" in its mid-quarter report for Q4 2013, we are inclined to believe they are being very candid in their own self-assessment. The Dec. 31, 2012, balance sheet reflected current assets of $311 million vs. current liabilities of $49 million. That looks pretty strong to us.
If one worries that of those current assets, net receivables constituted $221 million, we would point out that there was also $83 million in cash at that date, which provides a quick ratio of 1.7x, a generally considered very healthy metric on its own. Adding to that the fact that the company collected more than $253 million in receivables in 2013, we believe we are safe in saying the Dec. 31, 2013, balance sheet should look exceedingly liquid.
The next quarterly earnings report is expected on March 6, 2014. The consensus EPS estimate for TGA is $0.41 among five analysts covering the company; the high and low estimates are $0.69 and $0.27, respectively. If the consensus of $0.41 per share were to obtain in each quarter of 2014, that would equate to TransGlobe Energy being on sale currently for a P/E ratio slightly over 5. We believe this operator has learned how to succeed in a challenging environment, and for our money we would bet on them not only surviving in Egypt, but thriving -- if anyone can.