TransGlobe Energy Is Undervalued

Jul.16.14 | About: Transglobe Energy (TGA)

Summary

TransGlobe is undervalued due to political and economic uncertainty in the regions it operates.

It is trading near book value.

TransGlobe is worth more based on fundamentals.

Company description:

TransGlobe Energy Corporation (NASDAQ:TGA) is a Calgary-based, small cap ($517 million) oil and gas exploration and development company focused on the Middle East/North Africa region with production operations in the Arab Republic of Egypt (most of the operations) and the Republic of Yemen (barely significant to EPS).

Synopsis:

TransGlobe Energy is undervalued at the $6.90 per share area due to the political and economic uncertainty in the region it operates. As the political and economic landscape becomes relatively less uncertain, the stock price may recover to around $7.30-$7.60 per share depending on circumstances.

Recent events:

TransGlobe Energy was once trading as high as $18.74 per share in late 2010 when Egyptian President Mubarak was in power with the stock price heading as low as $7.10 per share in late 2011. The frustration of the Egyptian people led to his replacement by President Morsi in 2012, with the promise of reform and economic prosperity but met with disappointment. President Sisi (then a General under Morsi) mounted a coup (depending on who you ask) in mid-2013 against Morsi. This disruption complete with tanks, burning buildings and deceased bodies drove to a low of $5.80 per share. At the time, book value per share was $5.91 per share. The promise of economic prosperity under Sisi led the stock price as high as around $9.42 per share in October 2013. Recently the stock price has traded down to around $6.90 per share ($6.87 book value per share) as a result of newly imposed reductions in energy subsidies, raising fuel prices by as much as 78%.

Valuation:

Revenues and EPS for TransGlobe Energy can vary unexpectedly due to interruptions from political change that leave without knowing who will be in charge or when they will be paid. Annual EPS for 2010 was $0.59, 2011 was $1.09, and 2012 was $1.16, in 2013 annual diluted EPS came in at $0.89 (excluding an impairment charge, otherwise $0.65). First quarter 2014 EPS was $0.22. This would put the stock on track to at least meet the low end of Wall Street EPS estimates at $0.80 for 2014.

Taking the $0.80 figure and assuming a zero growth scenario with a 10% required rate (PE of 10), the company would price out at $8 per share. The stock price hasn't spent much time above that in the last year. This is not intended to mean the company can't grow, it just shows the value presented by the current $6.90 price with a 10% required rate of return and zero growth. The price of $6.90 implies an 11.6% required rate of return with zero growth and $0.80 EPS.

Using a different approach to valuing the company, let's look at how much oil the company has and what profit it translates to on a per share basis. As of 2013, the company had proven and probable reserves of 45.3 million barrels. Recent oil prices are around $100, but I will use a conservative $90 per barrel. That would mean $4.077 billion is in the ground. With a net income margin of 12.2%, that leaves $497.394 million in profits or $6.07 per share of value to the shareholder at depletion. Adding in the cash at $1.44 per share, for a total of $7.51 per share liquidated. Just above the book value of $6.87 per share. Certainly, there will be other variables that come into play over time, but this provides another perspective when determining value under these circumstances.

The rock bottom price appears to be $5.80 per share, since that was when the violence was at its worst in Egypt and at the time the Yemen operations were all but shut down. Notably, the book value per share was $5.91 per share at the time.

So, which number should you use as a share price. That depends on how optimistic you are about peace in the Middle East. I am willing to wager the share price will not re-visit $5.80 again, but I could be wrong. If it does, it seems this stock would be an even better bargain than currently. I was holding shares at this price before and avoided panic selling by sticking with the math as presented here. My recent acquisitions at around $6.90 suggest I am split between the rock bottom price and the liquidation approach.

Ratios: Current Ratio (1Q '14) 7.98, Book Value per Share (1Q '14) $6.87, Cash per Share (1Q '14) $1.44, Times Interest Earned 19.8, Return on Equity (A '13) 16.8% (ex item), Operating Cash Flow per Share (A '13) $2.43, Total Debt to Assets (1Q '14) 25.5%.

Summary:

TransGlobe is a well-run company with solid financials operating within an extreme environment. With all the difficulties the company faces, why buy the stock at all? Egypt needs the oil to run its economy. The existing military has always protected the oil fields and TransGlobe's operations during times of violent political upheaval. The government also receives large royalties from the oil revenues. It would be foolish to allow harm to come to TransGlobe or to attempt to drill and pump the oil themselves. Even though revenue interruptions occur, it does eventually get paid. Egypt very much needs TransGlobe.

Although many Wall Street analysts have higher price projections than those in this report, they have been publishing those for years. The investor assumes circumstances will improve in a sustained and beneficial way at his own risk. The $6.90 area is a good entry point for the stock. Cheaper is better, but lower prices may not materialize. A good exit point is around the $7.30-$7.60 area. The stock has difficulty reaching $8 and some form of political event tends to keep it lower. Better to take profits and set a price alert for another round trip.

Disclosure: The author is long TGA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The stock in this report is high risk. Consult with your professional financial advisor before deciding to buy or sell. The author of this report owns the stock and will purchase or sell the stock based on valuation. No reward is being received by the author of this report from the subject company.