(Editor's Note: Investors should be aware that trading of BLKPF is illiquid. Investors interested in taking a position would be encouraged to consider the PXX.TO listing on the Toronto Stock Exchange for higher liquidity.)
- BlackPearl Resources' strong recent share price performance despite a difficult oil price environment has caught our attention.
- The company has solid and growing cash flow from two producing assets and two highly attractive growth projects.
- The Blackrod project is a potential company maker.
- BlackPearl Resources currently appears undervalued, and timing seems opportune for an entry.
- Several catalysts should lead to attractive gains throughout 2014, and well beyond.
BlackPearl Resources (OTCPK:BLKPF) is a junior oil exploration company with heavy oil and oil sands projects in western Canada. The company generates solid cash flows from two assets and has been funding development of two growth projects from cash flow.
While the producing low-cost assets provide a strong safety net towards the downside, we also see blue-sky potential to the upside through two organic growth projects; setting up a highly asymmetric risk-reward scenario.
We believe that the price environment for Western Canadian Select is nearing a structural and seasonal low. Investments in Canadian oil companies should benefit from a narrowing WTI - WCS spread later in the year. BlackPearl Resources is a low risk - high reward investment vehicle perfectly positioned to play Canadian oil in 2014.
Protecting the Downside
BlackPearl Resources has established a strong moat to protect the business against downside risks. The company stands out among junior energy stocks in this respect. We feel it is appropriate to consider these lines of defense before moving on to discuss the tremendous upside potential of this company. The following bullets give a summary of the protective layers described in greater detail below:
- Cash flow from existing operations supports ongoing business and pays for development activities.
- Exceptionally strong balance sheet and liquidity.
- Management has skin in the game.
- Conservative management approach.
- The mix of assets and reliance on proven technology minimizes operational risks.
ad. 1) Unlike many other oil and gas explorers of similar size, BlackPearl Resources actually has cash flow positive assets to support its activities. The company produced around 10,000 boe/d (up 11% from the year prior) at an average cost of around $20/boe in 2013. This production is 99.5% oil-weighted.
With a market capitalization of $645M, BlackPearl Resources is still a minion among oil producers. However, contrary to many peers of similar size and standing, BlackPearl Resources does not need to rely on funding through capital markets. Cash flow from operations is more than sufficient to keep the company afloat, and also provides capital to develop the company's growth assets.
ad. 2) The company has a very strong balance sheet with $8M in cash and $105M undrawn in the credit facility. And there is only $10M in long-term debt leading to a miniscule debt-to-EBITDA ratio of 0.12.
We expect BlackPearl Resources to expand the balance sheet for development of one or both of the growth projects described below. The clean balance sheet is a great basis for such an initiative when the time is right.
ad. 3) Management owns 10.5% of the company aligning management's and shareholders' interests. With management financially committed to such a high degree, shareholders can be certain that their interests will come first in any growth initiative.
ad. 4) As if to reinforce the point made under 3) we note several occasions where management has acted protectively and conservatively in the past. Most recently in mid-2013 intentions to sell $350M of debt were terminated when conditions were judged unfavorable. Growth at all cost does not seem to feature in this company's agenda.
ad. 5) The company employs a mix of conventional wells, thermal wells and ASP flooding for its projects and operations. These are off-the-shelf methods minimizing operational risks. The mix of these technologies also provides flexibility in adjusting production to market conditions if necessary.
The company's organic growth plan calls for a JV partner for the development of the Blackrod project; and BlackPearl Resources has already stated that it is actively looking for a suitable candidate. If management repeats on its own history, the growth plan could be realized in very short order based on the preparations put in place over the past years. Our investment thesis assumes this scenario and the associated growth trajectory of production to grow tenfold within just a few years.
Management has pledged to keep the debt-to-EBITDA ratio between 1.0 and 1.5 over the longer term and to remain conservative in financing growth initiatives. BlackPearl Resources is currently un-hedged, but has indicated willingness to enter into hedging contracts during periods of major spending.
In order to understand BlackPearl's business plan, it is imperative to understand the nature of the company's assets. We will give a quick overview of the most salient features in the following, and will also provide links to the company website for further details.
The company's operations have been performing very well, creating a steady increase in revenues and gross profit for quite a few years already as illustrated by the chart below. We would like to emphasize that almost linear growth like this, while developing new assets, is no mean feat and testimony to the management's capabilities.
Just under half of the company's oil production is coming from conventional wells at Onion Lake in Saskatchewan. There are 300 wells already drilled and 100 (2P case) to 150 (2P+2C case) more to be completed; enough for 3 to 5 years of additional development. And more well locations are likely to be found by further delineation drilling.
About another third of total oil production is coming from the Mooney Field in Alberta where BlackPearl Resources is employing ASP flooding with great success. This project has an estimated life in excess of 40 years and production is projected to increase from currently 3,300boe/d to 8,000boe/d with time.
Phase 1 at the Mooney Field will reach peak production in 2014. Development of Phase 2 is under way and further phases are planned. Application of ASP flooding has unlocked the value of this project and should keep cash flowing for many years to come.
There are a couple of smaller non-core projects with producing wells but these are not material to the company.
Having free cash flow from these well fields provides flexibility in terms of financing and timing the development of growth assets, described in the following:
Growth Asset 1 - Onion Lake EOR Development
A portion of the Onion Lake project is amenable to thermal development in the Lower Cummings formation. Results from a two well thermal pilot on the property in 2009 confirmed the economical viability and high value of this project. The reservoir ranges between 10 and 25 meters thick in this area of the Onion Lake lands making it suitable for SAGD development.
BlackPearl Resources plans to spend $300M to $350M in total on the Onion Lake Thermal EOR. A first stage will come with a price tag of $175M. Regulatory approval has been obtained for a 12,000boe/d operation, enabling the re-classification of more than 70M bbls into 2P reserves. Payout is estimated to 3-5 years and the project life is 25+ years.
This project is perfectly suited to be funded internally from debt and cash flow. The project has been de-risked by operating a pilot well, and also by experience gained from other similar well fields operating successfully in Saskatchewan. The Onion Lake project is in close proximity to existing infrastructure, and the project uses well understood technology and tried engineering.
We expect this project to be initiated in the near future and first production possibly before the end of the year.
Growth Asset 2 - Blackrod Project
This second growth project represents a gear change from the other assets described so far. The Blackrod project is located in the Athabasca oil sands region and has the potential for production of 80,000 boe/d, or eight times the company's current production capacity. Approval for this project is expected in 2014.
The net pay for the Blackrod project is continuous and has a thickness of 10m to 28m at a depth of 300m. The project life is estimated to 25+ years.
BlackPearl has undertaken a pilot in order to de-risk the project and has achieved commercial rates with it. To date this pilot has produced more than 200,000 boe. A second, longer well pair has been drilled and steam injection has already started. This second well pair will further de-risk this project and confirm the economical viability.
BlackPearl Resources is planning to build this project in stages starting with a 20,000 boe/d first stage followed by two 30,000 boe/d stages. Capex for the first phase has been estimated to $750M to $800M. The company is actively looking for a JV partner to develop this highly attractive project.
Western Canada Select Pricing
Western Canadian Select oil, or WCS, is priced at a discount to the American benchmark WTI price. The spread between the two oil prices varies considerably and depends on a number of factors. The chart below illustrates some number crunching we have done on historical data of this spread. We used monthly data since 2005 for this study.
We note that the mean as well as the median for the WTI-WCS spread are lowest in mid-year, and highest in the winter months. We also note that monthly minimum spread values are almost constant just above 10%, but monthly maximum values are almost double in the winter months when compared to summer months.
There are two interesting conclusions on the seasonality of the WTI-WCS spread to be drawn from this chart.
- On average, the spread narrows in summer and widens in winter.
- If the spread was high in winter, it has dropped significantly in summer without fail in each of the past nine years.
These observations are interesting, considering the current spread of 40% which is at the high end of the range. If the spread develops in 2014 as it has in each year of the past decade, we can expect the spread to narrow to at least half its current value by early summer.
Presently there are in fact a number of structural reasons for high price pressure on Canadian oil, and consequently for a high spread:
- Maintenance across the crucial pipeline network operated by Enbridge (ENB) has been causing bottlenecks and a transportation backlog exacerbated by the ramp-up of Exxon Mobil's (XOM) Kearl oil-sands project.
- A fire at Citgo's Lemont refinery has caused a bottleneck in refining capacity for Canadian oil.
- Canadian authorities are reviewing rail safety recommendations for oil transports following last year's Lac-Megantic tragedy.
These reasons should be resolved within months setting the scene for the spread to narrow considerably; and for margins to rise for Canadian oil producers. Add to that the possibility of positive news with regards to the Keystone XL pipeline as a possible bonus.
The oil price in general has been range bound, and we expect it to remain like that for the foreseeable future. Such a steady oil price in combination with a narrowing spread would mean higher prices for Canadian producers.
We find that BlackPearl Resources is perfectly positioned to benefit from such a price development.
BlackPearl has just released its annual reserve estimates. Proved reserves increased by 302% to 64M bbls and 2P reserves increased by 36% to 231M bbls.
With this reserve estimate the company has also released an NPV estimate derived by an independent consultant. During the past year, the pre-tax NPV (10%) based on 2P reserves has increased by a whopping 89% to $2.2B, or 3.4 times the current enterprise value.
This immense reserve and NPV growth was driven to a large degree by the receipt of regulatory development approval for the Onion Lake thermal project and the associated reserve upgrade; the numbers illustrate the immense value of this growth project.
We note the conservative nature of this valuation. We have used our own discounted cash flow model at 8% discount rate and perhaps slightly more optimistic growth assumptions and have arrived at valuations in the order of five times the current enterprise value.
These number are further reinforced by the independent report provided by Sproule who calculate the per-share value considering the proved reserves only to $2.44, which is already higher than the share price at the time of writing.
Per-share value for 2P reserves is $7.30, or three times the current share price. And the per-share value for the best estimate contingent resources is an additional $6.99, or almost another three times the current share price.
In other words: the market barely values BlackPearl Resources for its proved reserves, and completely discounts probable reserves as well as best estimate resources.
Taking a different approach and looking at the numbers from a project-focused perspective, the market attributes no value at all for the two growth projects, and barely values the producing assets.
We also note that enterprise value is just 3.7 times revenue, or 7.8 times EBITDA.
Judging by all these metrics, and then some, we have come to conclude that BlackPearl is undervalued at the moment.
But Why the Low Valuation?
Firstly, BlackPearl Resources is not at the market's mercy with regards to funding and consequently the company has little coverage by sell-siders.
Secondly, Canadian oil plays have been neglected by the US markets in favor of sexier shale plays closer to home. Comparison of BlackPearl Resource's valuation with the valuation achieved by Bakken or Texan plays results in head-shake material.
Thirdly, BlackPearl Resources has effectively morphed from a junior explorer into a small-cap producer. Mr. Market has not quite woken up to this graduation and is still giving BlackPearl Resources the junior-explorer treatment in terms of valuation.
And lastly, oil juniors are very risky investment propositions and generally speaking, investors have been risk averse in the recent past. Despite being one of the most de-risked juniors your humble scribe is aware of, BlackPearl Resources still gets lumped in with the rest of the peer group. The tide seems to be turning, however. The stockmarket is awash with highly valued or overvalued stocks and investors seem to be looking increasingly to smaller caps and higher risk for better value.
Comparison With Peers
BlackPearl Resources has transitioned from junior explorer to small-cap producer status and we believe that it is appropriate to compare the company to a peer group of Canada-focused small-cap producers.
The table below lists such peers, sorted by market capitalization together with some salient data. We note that BlackPearl is much smaller than most peers in this group when measured by market capitalization. Longview Oil Corp (OTC:LGVWF) is just about the only other producer that comes to mind with a similar market capitalization as BlackPearl. However, this company is controlled by Advantage Oil and Gas (AAV) and has been spun off to maximize value from certain oil assets and emphasis is on dividend payments rather than growth. MEG Energy (OTCPK:MEGEF), Pengrowth Energy (PGH) and Bonavista Energy (OTCPK:BNPUF) represent companies comparable in nature, but somewhat ahead of BlackPearl Resources on an assumed growth trajectory.
(click to enlarge)
We note that BlackPearl Resources produces less oil per day than its larger peers, but the company is certainly on par considering operational metrics. Comparing netbacks, for example, we note that BlackPearl Resources' performance is towards the upper end of the range within this group as is the case for several other operational metrics.
We especially like to compare the valuation of 2P reserves and we note that BlackPearl Resources' investors can participate in one 2P reserve barrel at a price of $2.23; whereas the same barrel is valued much higher for its peers (up to $9.97 in the case of Bonavista Resources).
As we have shown earlier in the article, production is on a clear path to increase in volume to match the larger peers. And as production will increase, we can also expect market capitalization to mature to levels befitting of a seasoned producer.
Our comparison with peers confirms our conclusion gained from our asset valuation: BlackPearl Resources is cheap right now, and the share price is poised to increase in order to catch up with the company's peer group of Canadian small-cap oil producers.
Catalysts & Time Lines
We view BlackPearl Resources as a low-risk long-term growth investment, and assign a high probability on an eventual takeover. For the coming twelve months, we expect the following catalysts to drive the share price:
- Narrowing of the WTI-WCS spread is highly likely. News about this development should lead to renewed interest in Canadian oil plays, a tide that would lift all boats so to speak. BlackPearl will certainly share the benefit of a narrower spread.
- Full year and Q4 results for 2013 will be released on February 27. Operational data is already available and lead us to expect favorable financial results. We are speculating with a pop on the day.
- A development decision for the thermal project at Onion Lake is imminent. We expect financing for phase 1 to be announced in the near future, paving the way to more than double total production of the company.
- First results from the second pilot at Blackrod should become available within months. There is little doubt that these results will confirm the exceedingly positive results from the first pilot. We expect such an outcome to trigger increased interest by investors, as well as potential JV partners for this project.
- Approval for Blackrod development is expected sometimes in 2014 and will clear the way forward for this potential company maker. The share price should account for this milestone when it happens.
- Production from the Mooney well field should increase considerably in 2014. We expect revenue from this growth to bolster the balance sheet and create positive news items throughout the year.
- Announcement of a JV agreement for Blackrod is always a possibility, and would effectively catapult BlackPearl Resource to eye-level with the peer group introduced above. Such a move should lead to a re-rating of the company's share price in short order.
- We view BlackPearl as a very attractive takeover target. If such corporate activity eventuates, it will almost certainly come at a substantial premium and provide attractive gains for shareholders.
As explained in this article, we expect 2014 to develop into a year of substantial progress and growth for BlackPearl Resources. We will not be surprised at all to see the share price increase by 50% from current levels by summer, and remain in a strong up-trend throughout the rest of this year.
However, we see more than just a time frame of several months here. BlackPearl Resources is a stock that could be bought and put into a drawer without having to lose much sleep over the investment. It's the kind of stock that can be taken out of the drawer again and sold at a share price well into the double digits in a few years' time.
All our price targets immediately become obsolete as soon as a takeover offer eventuates. BlackPearl Resources has the strongest balance sheet among its peer group and will certainly not be negotiating from a distressed position. We would therefore expect a minimum premium of 50% over the share price at the time.
At the current point in time, BlackPearl Resources is probably too small to be of interest to the larger Canadian producers like Suncor Energy (SU) or Husky Energy (OTCQB:HUSKF); but any one of the peers mentioned in the table above might well be interested in corporate activities in order to bolster project pipelines and add to reserves. Especially the Blackrod project would be an interesting addition to the portfolio of any of these names. A joint venture agreement to develop the Blackrod asset might well be a good starting point for possible future action.
Management has developed and sold a large project before very profitably, namely Blackrock Ventures for $2.4B to Royal Dutch Shell (OTCQB:RYDAF). We have reason to trust management to repeat this feat with BlackPearl Resources in due time, especially considering that management has enough skin in the game to align their interests with investors' interests in such a scenario.
A long-standing down-trend (red line in chart below) was broken just prior to New Year, and a golden cross occurred around the same time.
Despite dropping WCS prices we note a steady uptrend throughout the past seven months (green line), underpinned by the company's low-cost operations that were less affected by low prices than peers. We fully expect this uptrend to accelerate as soon as the WTI-WCS spread starts to narrow again in coming weeks.
The stock is not oversold as indicated by the RSI, and the MACD is neutral at the moment.
In our interpretation, this chart is showing a strong bias to the upside with weak resistance at $3 and stronger resistance at $4.
BlackPearl Resources is a long-term investment with multiple options for significant organic growth through its attractive project portfolio. While there is always the chance for sudden gains through a takeover, there is also much upside that can be realized by the company without relying on corporate activities.
Management is seasoned and has lived up to expectations in the past. The downside is limited, and risks have been minimized by the conservative business model of this junior oil producer.
BlackPearl Resources is not for those looking for high-risk multi-baggers; but it is an interesting proposition for investors looking for long-term growth stories with a strictly limited downside.
We strongly believe that now is a good time to invest in this company due to a price environment that we expect to turn favorable for WCS in the near future, the upcoming earnings call which we believe will be share price accretive, and due to multiple favorable signals derived from the company's chart.