- Evaluating Torchlight as a going concern reveals the stock is materially overvalued.
- Price is what you pay, value is what you get - Torchlight delivers little relative value to investors.
- Torchlight has proportionally more debt than its peers - introduces more risk.
Torchlight Resources (NASDAQ:TRCH) is a small, growing E&P company with a focus on onshore US oil exploration and development. Torchlight has been the focus of a number of articles addressing corporate risks such as prior violation of fiduciary duty and corporate bankruptcies by management, issues with its investment banker / research analyst, low levels of production versus high levels of historical capital expenditures and low ownership % of good wells versus high ownership % of bad wells.
Focusing on Torchlight's operating business unfortunately does not yield a much brighter picture for investors. Ignoring the other issues, Torchlight stacks up unfavorably compared to its peers. Other seeking alpha authors do an excellent job constructing a peer group of small growing oil and gas companies. I will borrow the comps used by Value Digger in his Top Idea Seeking Alpha article, which can be found here.
Value Digger identifies a number of companies that meet the following criteria:
1) They are junior producers (production up to 10,000 boepd).
2) They grow their production YOY.
3) Their production is light oil weighted.
4) Their producing properties are in the US onshore.
I will use Lonestar, the subject of the article by Value Digger, and 4 companies from the peer group he identified, to show how Torchlight compares on the valuation metrics Value Digger identified as key to evaluating oil and gas company valuations. The companies are:
1) RSP Permian (NYSE:RSPP)
2) Emerald Oil (NYSEMKT:EOX)
3) Abraxas Petroleum (NASDAQ:AXAS)
4) US Energy (NASDAQ:USEG)
5) Lonestar (OTCQX:LNREF)
The first valuation metric is EV/Current Production:
1) Per EV/Production: Here is the table with the first key metric:
EV / Current
|Torchlight||$120||~250 (70% light oil)||480,000|
(87% light oil/liquids)
(72% light oil/liquids)
(~94% light oil)
|US Energy Corporation|
(~91% light oil)
(~85% light oil/liquids)
Average $/boepd of the 5 comps is $131,000. Torchlight $/boepd is $480,000, or 3.7x higher than the comps.
2) Per EV/Proved Reserves:
Average $/BOE of 1P reserve of the 5 comps is $27. Torchlight $/BOE of 1P reserve is $80, or 3x higher than the comps.
3) Torchlight Versus Comps EV/EBITDA:
|US Energy Corporation|
*This EBITDA estimate assumes Torchlight grows production 400% in 2014 from Q4 2013, to an average of 500 boepd. This may be a high assumption, as it assumes Torchlight is able to raise substantial additional capital and remains a going concern, and it does not factor in the effect of additional capital.
Average EV/EBITDA of the 5 comps is 7.4x. Torchlight EV/EBITDA is 33.3, or 4.5x peer valuation.
Summary of peer valuation comps:
1) Average $/boepd of the 5 comps is $131,000. Torchlight $/boepd is $480,000, or 3.7x higher than the comps.
2) Average $/BOE of 1P reserve of the 5 comps is $27. Torchlight $/BOE of 1P reserve is $80, or 3x higher than the comps.
3) Average EV/EBITDA of the 5 comps is 7.4x. Torchlight EV/EBITDA is 33.3, or 4.5x peer valuation.
Across these three metrics, Torchlight is 3-4.5x more highly valued than its comps. From the current $4 per share, Torchlight would have to decline to $1.10 per share to trade in line with its comps, or down almost 75%.
It is possible Torchlight could decline further than 75% and trade at a discount to its comps. Torchlight is highly leveraged, with over $10 million of high interest notes outstanding, versus a recent negative $440,000 operating cash flow. This compares unfavorably to the comps above, which have debt to last quarter's annualized operating cash flow of 1-3x. Even if Torchlight achieves the above projected $3.6 million in EBITDA for 2014, it would be trading at almost 3x debt to EBITDA, which would be on the high end of the comps and would imply a lower valuation would be appropriate to mitigate the risk.
Torchlight trades at a large premium to its comps across a variety of established valuation metrics. Even if its corporate issues are ignored, its stock could decline by over 75%. And due to its high leverage levels versus its comps, it could decline further and presents a greater risk to an investor than its comps.
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Disclosure: The author is short TRCH. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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