It must be nice to be able to sit around all day and collect money. There are companies out there that worked a lot harder and are going bankrupt as a result. But at the end of its third quarter, East West Petroleum Corporation (OTCPK:EWPMF) reported that cash flow from operations was C$609K for the nine-month period. Since its partners have delayed drilling any wells in the current environment, it keeps adding to its cash hoard. There is an occasional well rework or maybe some lease bidding that uses some cash, otherwise the cash pile keeps building. Life can be tough.
However, management is just as tight with its cash as it is managing its assets. Rather than tender for outstanding shares, management applied to purchase the shares on regular transactions. At the close of the stock market on Friday, March 25, 2016, the market cap of the common stock was almost C$10 million. Since the company has almost C$8 million to spend on that market cap, management has permission this time to re-purchase nearly 10% of the company's common stock over the next year. It can re-purchase as much as 2% in any 30 day period, so if the price drops low enough, it will be interesting to see if the company receives permission to purchase more stock. It has the cash flow and the cash balance to do so if it chooses. In any event the company serves as a very large purchaser of its own common stock which will decrease the downside risk to investors for the next 11 months or so. That relatively large amount of cash on the balance sheet will also decrease the downside risk of the common stock.
Plus the company is debt free. It does have some partnership obligations, but it definitely has the cash to meet those obligations at this time. So where is the growth possibilities for a company like this? Clearly, an investor who pays C$.11 per share or US$.08 per share is paying mostly for the cash hoard with just a little left over for the company operations because the cash is roughly four-fifths of the market value of the stock. But subtracting the cash out from the market value and then dividing the remaining market value by the annualized cash flow figure results in a remaining value-to-cash flow of about 2:1. That ratio is exceptionally cheap by any measure, even for cash flow that will decline without new drilling. Few companies at this stage in their development have a ratio anywhere near that, and usually far more debt.
The company is a partner with Tag Oil (OTCQX:TAOIF). Together they share production from an operating lease that usually nets East West Petroleum roughly 200 BOED. Right now, one of the wells is having mechanical difficulties so it is offline, and another well is being evaluated for commercial production. So there is room for growth from the third quarter production, just by fixing one well, and having the other well produce commercially. However, the partnership does not move very quickly at these low commodity prices, but there is some very real room for growth by bring the G1 well onto production (if and when the partners decide to finally do that).
Source: February, 2016, Company Presentation
This was the latest budget for capital expenditures. However, partner Tag Oil had deferred drilling new wells in the current environment, preferring like East West Petroleum to just collect the money until things get better. Since both companies have a fiscal year that ends in March, 2016, both will have a revised budget for next year within a few months, but the chance of any wells being drilled in New Zealand before the end of the fiscal year is close to zero. The other items in the budget for New Zealand are going forward, but at a reduced activity level. So there is really not much of a cash drain from operating activities.
Romania, however, holds a lot of promise. Notice in the budget that the company has no cash obligations until commerciality is determined. At that point the company can decide to spend cash or go for a bank loan (or sell stock) if needed.
Source: February, 2016, Company Presentation
The much delayed drilling of the first well appears to be finally getting underway in the next quarter. These wells could prove far more significant to the company as this partner has spent much more money, and plans to spend a lot more money. Even in the current environment, this project is still going forward because gas prices in Europe are much higher than they are in the United States, so this gas project is very definitely viable in the current environment. A success here could easily send the stock price over a C$1 and probably to C$2 per share. NIS is a division of a well established and very reputable company (as discussed in previous articles). As such it is a very desirable partner. Just don't hold your breath waiting for the well to start drilling as delays seem very common in the industry right now. So another quarter or two of delays would not be out of the question, but right now things look good. If things go well, NIS could be carrying the company for more than 50 wells, but lets do one step at a time and survive the first twelve wells first. Investors should keep in mind that if NIS is spending the amount of money listed above on these wells (and much more before this step) and expects to make a decent profit, that same profit will be far more significant to the company than it is to NIS.
Source: February, 2016, Company Presentation
The wells that are being drilled are relatively shallow and low cost wells. They do not benefit as much from the current round of savings that other wells do because fracking is not nearly the cost factor that it is with unconventional plays. Back when the first article was written, a $35/b breakeven was clearly a great price. But since then, breakevens have fallen across the industry. While there is a chance that this company will find a way to decrease costs or increase production, it has a little less to work with than other companies, particularly in the unconventional part of the industry. So these wells may end up not having a large cost advantage or even no cost advantage in the future as the cost cutting continues. Nonetheless, this acreage does provide some cash flow, there are stacked plays that have zones that may be cheaper to produce, and possibly as yet undiscovered fields with unlimited possibilities. So the company has a steady production as well as a speculative side.
At current commodity pricing and with current economics, the operator is inclined to wait rather than build production from this field (new wells would be extremely marginal at best). But current production has a cash breakeven of approximately $20/b, so it makes sense to produce from the wells that have been drilled. Since neither the operator nor the company have any debt, there is no financial pressure of any kind to pressure production and drilling decisions.
In a five-year time horizon, this company should treat investors relatively well. The company has some fairly solid prospects in New Zealand in addition to the wells already drilled and producing. While investors can expect a relatively wide range of production from 150 BOED to 300 BOED because of the low number of wells and their significance to production when they go offline, the company will have more than enough cash flow to conduct business and decide what to do with that cash. The company still invests in speculative ventures from time to time, but it has begun to have enough success that at some point, investors should take notice and drive the price higher.
In the meantime, the cash hoard and the company's intention to repurchase up to 10% of its common stock should minimize the risk of loss of any part of the investment at current pricing. The current long shot that garners the most attention is the partnership with NIS in Romania, but should that fail there are prospects in New Zealand that could add value to the company, and other less likely possibilities listed in the annual report.
Investors could do far worse with many speculations than they will do with this company over a five-year time horizon. However, patience in buying the stock and using limit orders are very important considerations. Also, if a purchase decision is made, buying a batch of these companies (diversification) rather than going for a home run in just one usually works better.
Disclaimer: I am not a registered investment advisor and this article reflects my own opinions. I do not and will not advise anyone to invest or not invest in this stock. You have to do your own due diligence and your own homework, by reading the company's filings and press releases, as well as any other relevant information to make up your own mind at your own risk. Your investments must match your own risk profile as well as your desire to take on risk and the patience to see out speculative situations such as this.
Disclosure: I am/we are long TAOIF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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