How do you find – and play – the junior oil exploration stocks that can be 10-baggers for investors?
These are the companies that are drilling high-impact wells that can produce thousands of barrels a day. Their success can make shareholders a lot wealthier. As I wrote in my previous article, all these exploration plays are international – and the big winners often come from orphaned stocks that get financed at a very low valuation.
One of my subscribers, Craig in Seattle, rode OGIB stock pick Xcite Energy (XEL) and its North Sea heavy oil play from 60 cents to $6/share and sent me this email just before Christmas:
Thank you many times over – this “plucky” investor has just become a millionaire (on paper) due to you bringing it to my attention and of course me doing my own research.
I love those stories.
I’ll share with you how I find these companies, how I invest in them, and at the end I outline my current favorite international oil play, which has a big, short term catalyst.
1. My investment philosophy is to have the biggest “deal flow” I can get; create a big hopper of ideas and keep it full. So that means I have accounts with a lot of smaller, regional brokerage houses that cover the junior international exploration companies. In Canada, this means securities firms like (alphabetically), Cormark Securities, Haywood, Jennings Capital, Union Securities and Wellington West, among others.
Some of the national firms cover a few international juniors, (Canaccord Capital, GMP Securities, Macquarie Capital) but these junior companies often don’t raise a lot of money before their first big success, so it’s tough for the larger brokerage companies to make any money covering them.
Whatever firm you’re with, have them email you their morning letter and specifically an energy letter if they have it. (I get 8 each day, and get some of my best investment ideas from them.)
In the U.S., the analysts are more myopic and they don’t do near the small cap international coverage that the Canadians do. In fact, it’s not unusual for U.S.-based teams with international projects to list on the Toronto Stock Exchange first.
These companies often get orphaned as the investment bankers in Toronto and Calgary don’t know the management that well, and they fall through the cracks. That is, unless management can raise their own money or has a remarkable track record in exploration.
2. Another free and easy way is to sign up for the daily emails from some of the trade magazines – I read the daily email from Rigzone.com – I find that the best one. I also get the daily email from Platts.com and Upstreamonline.com. I also pay for The Daily Oil Bulletin in Canada.
3. I also have Google Alerts to track some very talented energy writers, like Toby Shute from the Motley Fool. Another great writer — though he doesn’t cover much in the way of international plays — is Allen Brooks of Musings from the Oil Patch.
4. I also create alerts for specific areas, like “offshore West Africa” or “North Sea oil”.
5. Every six months there is an investment conference of junior oil and gas companies in Calgary hosted by SEPAC – the Small Explorers and Producers Association of Canada that is worth attending.
If you do all these things, guess what will happen? You will create the single most important and powerful profit center of your investing career – your network of friends and contacts.
They send you research. They share talks they’ve had with other people. They may know of a junior company that has just assembled a big land package right beside a big new discovery in Timbuktu or Nowhere – and they’re doing a cheap financing.
OK, so now you are slowly building your information flow and have a list of several exploration stocks you’re following. Which ones to buy?
Like any other energy investment, you want to check out management, find out how much production they have, how big their land position is, and whether or not their production is nearby. You want to know the cash balance, and the share structure, and how transparent or corrupt the country is. (Download my Top 20 Questions to Ask Management at the top of my homepage).
I want to find a big play that is getting financed now, but won’t get spudded for several weeks or months. I want to put my money in when The Big Money comes in. I may have been watching the company for months, or longer, but I wait for The Money to come in. (I also call this the BIBA Machine – Brokers, Investment Bankers and Analysts.)
Getting the timing right is very important to me on these high-risk, high-reward international plays.
One thing I don’t want to do is be too early to the play. Perhaps management is waiting for permits of some kind – the politics and bureaucracy in many countries is very slow. Or maybe the hot property is in a legal dispute. Or there is some negative attribute (“hair on the deal,” it’s called) that is keeping The Money away. Without The Money, the chances are much less that the stock can build a speculative premium close to drilling. The Money promotes the stock with management.
And that is key. I like to make my investment several weeks before results are due on the well. That gives management time to promote the stock to analysts, who can get their reports out to their clients. Hopefully management can spend a lot of time doing investor presentations to institutions and other investors to create some excitement around the play. Who organizes most of those presentations? The Money.
I want this “excitement” to cause the stock to go up so I can choose to sell enough stock to cover the cost of my investment and ride for free on the results. If the timeline from investment to results is too short, I might not get that opportunity.
My favorite international oil play right now has all the attributes I’m looking for – except time. However, the market has cured that as the stock has had a strong speculative run.
Winstar Resources (WIXFF.PK) is only three weeks away from announcing the results of a high impact oil well in Tunisia, North Africa – the CS SIL #1, targeting to prove up an extension of a prolific oil field. I love this investment, because just a few small firms in western Canada, and only one in Toronto, have research on it. No other firms were actively supporting Winstar.
The company has a tight market capitalization with only 35 million shares out, no debt and was trading at 4x cash flow, despite high netbacks of $57/barrel on 2000 bopd [barrels of oil per day] production. So there was no speculative premium built in yet for this high-impact CS SIL#1 well. The fact that they missed last November on a $7 million well is, I’m sure, what helped create a low valuation.
This well is about 30 km away from the nearest production in south west Tunisia, but other producers in that area have had an 80% success rate with wells having IP rates of 6000 bopd.
IF Winstar hits on this well – and it has said publicly that four zones showed positive signs – what impact could that have on the stock?
In the first week of January there was a sale of Tunisian oil assets which gives an update valuation of Winstar’s assets and what the potential upside could be upon success of its current well.
Pioneer Natural Resources Company (PXD) announced that it has agreed to sell its Tunisian assets and production to OMV AG (OMVKY.PK), an Austrian company, for US$866 million. The assets are close to Winstar’s Chouech Essaida and Ech Chouech blocks, as well as several other concessions. Analyst reports valued the production at $94,000/BOE/d, and $22.80 and $14.65/BOE for the 2P and 3P reserves respectively.
Applying the OMV-Pioneer metrics to Winstar’s production and reserves, analysts suggested it values Winstar at $5/share on a production basis, and $9/share on a reserves (2P) basis, before any new production or reserves from the CS SIL#1 well currently being tested.
So IF this well comes in at 5000 bopd, an increase in market cap of $470 million ($94,000 x 5000) would not be ridiculous. On 36 million shares out that would add $13 a share to the current price of $6 – making it a short term triple. And there are multiple potential new well locations in the field if this well hits. They would enhance shareholder value for a few more years.
BUT if the well misses, I expect the company to halt the stock and see it open later in the $3.5-$4 range – at best.
The good news is that the company has no debt, has (great) positive cash flow, and a miss on this well will not destroy the company. But a lot of speculative money in the stock will leave over the coming weeks, putting constant downward pressure on the stock.
The hard part is gauging how the market may take a result that is a lot less than expected, say 500-1000 bopd. While that would likely be economic, the market might be happy and bid the stock up or disappointed and sell it down.
High risk, high reward. But these are the plays – for the risk-tolerant investor – that can be 10 baggers over short periods of time.
Disclosure: I own Winstar Resources (WIXFF.PK)