I’ve learned more about investing from reading the shareholder letters written by Warren Buffett than I have from any other source. Buffett has an uncanny ability to simplify the complicated and focus your attention on what is important. I came across the following thoughts attributed to Buffett, all of which I have been drawing on as an investor in 2011:
“Investing requires qualities of temperament way more than it requires qualities of intellect."
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. “
“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.“
In the second quarter of this year, as the stock prices of small and mid cap Canadian oil companies (focused on unconventional resource plays) were plunging I was gleefully buying. At the time I was sitting on a boatload of cash and was thrilled to be buying stocks at 70% of where they were a few months earlier.
I bought far too much, far too early. Stock prices of Canadian oil players continued to plunge through the end of September. Apparently I need to work on conserving my cash so that I have some when Mr. Market goes into hysterics (as he seems to do every second year).
However, I am still happy with the prices I paid, as I feel that I have a good handle on what these companies are worth, and I put much less than that. So I’ve hunkered down, and as cash comes in the door I happily continue to average down on my positions. And I’ve been drawing on those previously mentioned Buffett thoughts to help me stay focused:
- I’ve got control of my emotions and am not bothered by Mr. Market’s fluctuations (fluctuations being steep declines.
- I bought these companies (not pieces of paper) believing I would hold them for several years as they drill up their large unconventional resource plays into higher oil price.
- These companies are executing operationally, which is what is important.
One of the unconventional oil producers that I own and I have written about several times for Seeking Alpha is Petrobakken -- I actually mainly own the parent company, Petrobank (PBEGF.PK). Recently, I’ve observed something very interesting with respect to the analysts that cover the company. And what I’ve observed is that the analyst target prices don’t make any sense.
Consider the following variables at two points in time:
- Nov 2010 Petrobakken Production – 40,000 boe/day
- Production Guidance for Dec 31, 2012 – 46,000 to 49,000 boe/day
- WTI Oil Price - $85
- Range of Analyst Price Targets for Petrobakken - $21 to $30
- Actual Petrobakken Stock Price - $20.00
- Nov 2011 Petrobakken Production – 47,500 boe/day
- Production Guidance for Dec 31, 2012 – Over 49,000 boe/day
- WTI Oil Price - $99
- Range of Analyst Price Targets for Petrobakken - $7 to $21
- Actual Petrobakken Stock Price - $9.50
Let me summarize that, because it doesn’t make a whole lot of sense to me.
- Production up from 40,000 boe/day to 47,500 boe/day
- Petrobakken is going to exceed their high end 2012 exit rate production targets from a year ago
- WTI Oil prices are up from $85 to almost $100.
Despite production rising 20% (as well as exceeding even the most optimistic estimates) and oil prices rising 18% analysts have cut their target stock prices almost in half on average.
But it is even more confusing than that makes it seem. In addition to exceeding their most optimistic production targets the company announced that over the past 8 quarters they have assembled 120,000 acres in four emerging light oil plays (Swan Hills, Duvernay, Montney and Nordegg) at very low costs per acre.
Now, it seems to me that when production is better than expected, oil prices are higher than expected and the company asset base is much larger than expected, the average target price should increase -- not decrease by 50%.
Did Petrobakken issue any shares in 2011 that might account for this reduction in value per share estimates by analysts? Not a single one.
I understand Mr. Market taking Petrobakken down from $20 to $9.50. Mr. Market is an emotional fellow prone to instances of excessive pessimism or optimism. What I don’t understand is how the analysts can change their targets so dramatically despite operational success.
As is often the case, the analyst price targets follow the movement in the stock price rather than the progress of the business. No analyst wants to look foolish and have a $30 price target on a $9.50 stock no matter what the underlying business might actually be worth.
Fortunately for me, I’m not afraid to look foolish, and I don’t really care what Mr. Market thinks on a daily basis. I thought Petrobakken was worth $25 to $30 a year ago and the company has done nothing in 2011 to change what I think the business is worth.
If anything, given that production is better than advertised, and given that the company has assembled a material 120,000 acres in additional resource plays, valuation estimates should be higher than they were 12 months ago.
One Item of Concern
Petrobakken does have one item that the market (and likely the analysts) are focused on, which dampens enthusiasm for an excellent end to 2011. That item is a one day put option held by holders of Petrobakken’s $750 million of convertible debt.
In February 2013 (not 2012) the convertible debt holders have a one day one time option to request immediate repayment. Petrobakken can make this repayment either through shares or cash. At the current depressed stock price, the dilution would be atrocious should the repayment be in shares, so Petrobakken is going to have to find some liquidity (assuming the share price doesn’t increase quite a bit in the next 16 months) to handle any debt holders exercising the put.
The company has a variety of options available to deal with this, which include:
- Repaying the convertibles with another debt instrument (increase in credit line or high yield market)
- Renegotiate with the holders of the convertibles (increase the coupon, decrease their conversion price)
- Raising some cash through an asset sale
- Reduction in capital spending
- Reduction in their dividend
- Continued increase in their cash flow
Petrobakken has indicated that the answer will be some combination of those items above. It is currently engaged with its investment banker so it can have this issue crossed off well in advance of the put date.
I saw a recent report from one of the analysts that suggested Petrobakken was worth $7 per share. In his report he basically assumed that the entirety of the convertible bonds would be repaid using shares, and on top of that assumed that the share price at the time of conversion would be under $10.
His assumption of complete repayment of the convertibles through dilution at share prices under $10 would be realistic if Petrobakken was being managed by an egg salad sandwich. In the real world, the company is managed by humans who have been aware of this put option for a long time and have various levers to pull in order to deal with it.
I’ve been holding this company (mainly through the parent co.) for just over a year. Operationally things are going according to plan, so I see no reason to worry about the current stock price. I’ve repeatedly reviewed the various businesses (Petrominerales (PMGLF.PK), Petrobank, Petrobakken) that CEO John Wright has grown from nothing into billions of dollars of shareholder value. I’m certain that given his track record of success, I can safely assume that he is not an egg salad sandwich, and I’m giving him and his team a multi-year time period to make me some money.
Disclosure: I am long PBEGF.PK, PBKEF.PK, PMGLF.PK.