The economic attractiveness of enhanced oil recovery, infill drilling, field workovers, and similar measures designed to increase production from existing or played out fields is based on predictability. A certain amount of capex on the front-end should yield a more-or-less predictable amount of production on the back-end. When a company's business model and market cap are based on delivering this kind of predictable result, any failure is a serious problem. When a company continually fails to deliver on this – as Cano Petroleum (NYSEMKT:CFW) has - it's both a crisis and an opportunity.
On the crisis side, at the current price of $3.75 Cano's stock is off more than 60% from its mid-June peak of $9.40. Part of the decline is due to falling oil prices but the larger part is due to yet another quarter of zero production growth despite a business model based not only on predictable growth but on claims of very high growth.
In October, 2007 Cano estimated its risked total production for 2008 at more than 3,200 boe/d, up from 1,500 boe/d in 2007. (See slide 29 in this conference call.) Actual 2008 production has been flat in the 1,500 boe/d range with no immediate prospects for change. For a company that as recently as last October estimated 50% compound annual growth through 2012 off the 1,500 boe/d base, this is a dismal result.
In the conference call associated with the most recent operational update (July 22, 2008), the company explained (or at least claimed) that the waterflood at the Panhandle field, the ASP injection at the Nowata field, and the resumption of infill drilling at the Cato field were all on track to deliver production increases by year-end.
With respect to the key Panhandle waterflood at least one thing is certain – if a meaningful response (fluid flow and oil cut) is ever going to happen it has to happen in the next six months or so. Enough water will have been injected by then that there will no longer be any possible explanation for poor oil production other than management's inability to deliver. At the Nowata field, a preliminary response is possible by the end of the year but a hard technical limit, as at Panhandle, will not have been reached. At the Cato field, resumption of infill drilling should put production back on the acceptable growth incline displayed earlier in the year.
All of which brings traders to the opportunity part of the picture. With the stock at about $3.75 per share, Cano's enterprise value [EV] is about $240M. (See the company's presentation for more information.)
This is roughly 10% of the company's pre-tax PUD PV10 of $2.24 billion (albeit at $140 oil and $13.15 gas, the prices on June 30, 2008) and roughly 55% of its pre-tax PDP PV10 of $425 million.
While there is justifiable skepticism about Cano's ability to convert its PUDs (proved undeveloped reserves) into production on a realistic schedule (hence the 90% discount), the 45% discount from PDP (proved developed producing reserves) is unheard of for a going concern with any kind of viable business model, let alone one with potentially very large PUD-to-PDP conversion potential. Cano did, at least, convert 1.4M Boe of PUDs to PDPs in the quarter, which is positive. Cano also recently did a large equity raise and is considering divestitures of non-core assets.
While the purpose of the equity raise and the potential divestitures is to fund capex at Panhandle, Cato, and Nowata, the question is the same as it has been for many quarters: can Cano's management deliver? Cano's enterprise value suggests that expectations could hardly be lower. Setting the bar this low also means that almost any kind of success – in what should be a highly predictable business model – would justify a significantly higher stock price.
CFW at $3.75 offers value for traders willing to bet that management can finally deliver on at least some small fraction of its long-standing but yet unmet promises of rapid production growth.
Stock Position: Long.