TransGlobe Energy (NYSE: TGA) is a Canada-based small cap company (market capitalization $123.15 million). The company's core business is the exploration and production (E&P) of oil and natural gas, with projects in Egypt and - since the recent acquisition of the Harmattan assets from Bellatrix (NYSE: BXE) - in Canada. The Egyptian oil production in the third quarter of 2016 has been 11700 BOE/d and, according to TransGlobe Energy estimations, will be between 13000 and 15500 BOE/d in 2017. The Canadian assets will produce between 2500 and 3000 BOE/d in 2017. So a production in the range of 16000-18000 BOE/d has been estimated for 2017.
The firm's financial position is superb. It enables the company to endure the downturn in oil prices started in 2014, to continue with the exploration program taking place in Egypt and to take advantage of the opportunities appearing at bottom of the oil cycle, like the acquisition of the Harmattan assets. Basically, the strong financial position and the oil price turndown have made a good combination for TransGlobe Energy.
With the acquisition, TransGlobe gets greater leverage to oil prices. It will reap benefits when the next change in crude oil cycle takes place. The company's financial position provides enough flexibility to push shale oil production of the Harmattan acquisition at the right moment.
TransGlobe Energy has a robust balance sheet, which reflects management's diligence during the previous upward oil price cycle. The company has neither burnt cash nor incurred in high levels of debt with overpriced acquisitions.
$100 million in cash ($50 million of which was used in the acquisition of the Harmattan concession) and NCAV per share of $0.73, representing 42% of the market value and well over the values of the period 2007-2011, show TransGlobe's financial strength.
The NCAV has been decreasing since the maximum of mid-year 2014, exactly when oil prices started to shrink. Even so, the current value is positive and well over the mean of the period 2007-2011, reflecting the solid financial shape of the company after two and a half years of the turn in the oil price cycle.
Harmattan Assets Acquisition
In December 2013, Bellatrix acquired, at the height of the previous oil price cycle, Angle Energy Inc. for CAD 576 million. The Harmattan concession constituted the major asset of Angle Energy, representing 60% of proved reserves and 70% of proved plus probable reserves.
In December 2016, only three years later, with oil prices depressed, TransGlobe Energy has acquired the Harmattan assets for a total of CAD 80 million. So basically, it paid one-third of the price paid by Bellatrix in 2013 for said assets. In the next section, there is a more detailed analysis of the acquisition.
TransGlobe Energy's healthy financial position has allowed the acquisition of new assets at an impressive price, making good Baron Rothschild's statement, "The time to buy is when there's blood in the streets" - in this case, the streets of the oil fields.
Moreover, the Harmattan area produces shale oil and is seeing a fast decline in production. TransGlobe Energy can decide when the right moment is to push Harmattan production, probably when a new phase in the oil price cycle starts, whenever it takes place. The company is not in a hurry. At the moment, it foresees drilling wells for exploratory purposes in 2017. In our opinion, this is the appropriate approach. As TransGlobe does not have a desperate need for cash, it can delay operational drilling on the Harmattan assets until reserves are properly assessed and oil price recovers.
In due time, production could be easily duplicated. In the last four years, there has not been any operational drilling on the assets, and there are already enough proved reserves. As an indication, when Angle Energy was intensively drilling on the area, more than 7000 BOE/d were produced.
So basically, TransGlobe Energy only needs to wait until the apple is ripe and then put the machinery in motion for converting all that oil (and natural gas) into cash.
Transaction Detailed Analysis
Harmattan production was 4.950 BOE/d in 2014, 34% natural gas, 24% light oil, condensate, and 37% natural gas liquid.
In the period (three years) in which Bellatrix operated the Harmattan property, only one horizontal test well (0.5 net) was drilled and completed. In 2013, as reported by First Energy Capital, the total production of Angle Energy was 10.500 BOE/d, of which 7200 BOE/d were produced by the Harmattan concession. The total proved reserves in the Harmattan assets were 23 MMBOE and the proved plus probable reserves were 42.9 MMBOE.
Harmattan was producing 7200 BOE/d in 2013, and then fell to 4950 BOE/d in 2014. Now it is producing 3079 BOE/d. A decrease of 57%, but, as it has been already mentioned, Bellatrix practically did not drill on the area in the three years that it operated the Harmattan concession. The decline is currently estimated in 12% per year.
The drop in production is compatible with the decline observed and measured by Angle Energy in the area wells. See the figure below, where the company presented the oil decline curve for the wells operated in the Harmattan Cardium formation.
Source: Angle Energy
The Harmattan proved reserves were 23 MMBOE in 2013. Three years later, in December 2016, they have been calculated to be 12.1 MMBOE - a decline of almost 11 MMBOE. How can this decline be explained? Partly due to operations. With an operational mean of 5000 BOE/d, in three years, around 5.5 MMBOE would have been depleted from the oil reserves. The remaining losses would be just a write-down of reserves following the decline of crude price that started in mid-2014.
So let's compare the Bellatrix acquisition price in 2013 with the one paid by TransGlobe Energy in 2016. First, we calculated the price paid by Bellatrix for the Harmattan assets in 2013. (Table 1). The estimated price is compared with the price paid by TransGlobe. Two kinds of corrections have been done in order to make the comparison more realistic. First, the magnitude of the reserves has been taking into account (Ratio Acquisition (pondered by Reserves) file), and secondly, the ratio has been calculated in US dollars. The price paid by TransGlobe Energy in 2016 is, as already mentioned, around one-third of the one paid by Bellatrix in 2013.
Table 1: Angle Energy acquisition by Bellatrix versus Harmattan acquisition by TransGlobe
|Oct 2013||Angle Energy Assets||576||37.2||60.9||0.97|
Table 2: TransGlobe Energy acquisition ratios. Comparison with the acquisition of Angle Energy by Bellatrix
|Harmattan Price According Proved Reserves (2014)|| |
|Acquisition ratio|| |
|Acquisition ratio (weighted by Reserves)|| |
Basically, what TransGlobe Energy has acquired is not only the current production cash flow of the concession (the remnants of Angle drilling), but future production. When drilling is resumed, production will increase. And TransGlobe Energy can wait calmly to drill until the oil price increases, due mainly to its powerful financial position.
TransGlobe Energy Earnings Model
A simple earnings model for TransGlobe has been developed:
Earnings = Netback - Administrative Costs - Depreciation (- Unusual Expenses)
The netback from Harmattan operations is calculated from Bellatrix reports. The Administrative Costs, Depreciation and Unusual expenses are the last four years' mean. Administrative Costs have been increased by 10% to include the extra costs of the Harmattan acquisition.
Earnings are calculated in two steps. In the first step, Brent price is set at $45 and oil production set at TransGlobe's production in 2016.
In the second step, Brent price is set at $90 and production in the range estimated by TransGlobe for 2017 (as an exception, the Canadian production is estimated at 1000 BOE/d more and, on the other hand, the Egyptian production is in the low range of the 2017 estimation).
A linear interpolation has been done between these two calculation points. The company price is calculated by assuming the price-to-earnings ratio (P/E) at 15.
According to the model, TransGlobe Energy would start to generate profits with a Brent price of $63. Were Brent at $90, the stock price would skyrocket to $16.5. And that is without taking into account any major oil discovery in Egypt or the recently acquired Canadian assets.
Table 3: TransGlobe Energy model result
|Country||Brent ($)||BOE/d||Netback ($/BOE)||Operations Flows (M$)||Administrative Costs ( M$)||Depreciation (M$)||Unusual expenses (M$)||Net earnings (M$)||Total Net Earning (M$)||Total Net Earning (M$) - Without unusual expenses|
TransGlobe Energy enjoys solid financial health, and it will continue to do so in the medium to long term. Not only has this allowed the acquisition of new assets at a bargain price, but it will also continue supporting the company's normal operations through the downward crude price cycle. It also provides flexibility for the operational program of the newly acquired assets: TransGlobe Energy does not need to increase production in the Harmattan concession immediately, and can wait to do so until oil prices recover.
The recent acquisition of the Harmattan concession also permits the company to diversify its activities, re-entering into the safer environment of Canada. These new assets will bear fruit when the current oil price cycle reverses.
The pricing model gives a very important return in the plausible event that crude prices surge again. It compensates the geopolitical risks associated with exploration and production in Egypt.
So for us, TransGlobe Energy is a clear long buy.
Disclosure: I am/we are long TGA.
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.