Value Investors: This Overlooked Investment Idea Is Too Good And True

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About: Corridor Resources Inc. (CDDRF)
by: Value Digger
Summary

Corridor Resources is an overlooked, profitable, debt-free and cash-rich firm.

Corridor's Enterprise Value is negative and zero at C$0.56/share (Toronto) and C$0.60/share (Toronto) respectively.

The company is estimated to continue to generate significant annual free cash flow from its main asset for many years to come.

Additional catalysts include the development of the other assets and a buyout from Pieridae Energy for the support of an LNG plant.

I don't write often about debt-free and cash-rich firms with negative Enterprise Value. Actually, I rarely write about them. And I rarely write about them because it's almost impossible to find them.

Last time I wrote about an overlooked, debt-free and cash-rich firm with negative Enterprise Value was in November 2015, when I recommended Petrodorado Energy (OTC:PTRDF) at C$0.24/share (Toronto), as shown in my article here. Including the special dividend, Petrodorado Energy has returned 120% since my recommendation.

And this is also the case for Corridor Resources (OTC:CDDRF). This is another overlooked, debt-free and cash-rich company whose current Enterprise Value at C$0.56/share (Toronto) is negative.

Obviously, I'm not trying to make outsized returns by investing in highly leveraged plays such as Seadrill (SDRL), Peabody Energy (BTU), Westmoreland Coal (WLB) and Teekay Offshore Partners L.P. (TOO) while hoping that a white knight will come to save the company and take it out of its misery. This is why, I recently encouraged investors to steer clear of Westmoreland Coal at $11.30, as shown in my article here. WLB currently stands at $4.30.

Fortunately, I learned at the very beginning of my 30 years of investing career that luck and white knights are not investment criteria for canny investors. Instead, I focus on undervalued, debt-free or low-leveraged companies. On the one hand, my subscribers and me make high returns quite often. On the other hand, we sleep peacefully at night.

The Starting Point Before The Settlement

Corridor Resources is a consistently profitable, debt-free and cash-rich energy producer.

As of March 2017, it has cash and working capital surplus of C$30.7 million and C$33.2 million, respectively, owns significant infrastructure (i.e. plant and pipelines) and produces approximately 1,200 boepd (100% natural gas) in the McCully field in New Brunswick, as shown below:

Source: Corridor's presentation

and below:

Source: Corridor's presentation

It's also noteworthy that the McCully field in New Brunswick hosts low decline wells (~10% annually) while requiring minimal and predictable future development capital every year. As a result, the company has been generating significant annual free cash flow while also increasing its working capital surplus over the last years.

Moreover, Corridor has been implementing over the last couple of years an excellent optimization plan to get the most out of its production and maximize its annual cash flow. Actually, Corridor's production optimization objective is to achieve similar field operating netback when compared to a continuous production model, while deferring production volumes for the future and extending the McCully field reserve life.

On that front, it restricts its production (to varying degrees) in the McCully field in New Brunswick during the months from spring to fall. These voluntary shut-ins allow the producing horizons in Corridor's wells to build up reservoir pressure, which in turn results in flush production once the wells are placed back on unrestricted production. Corridor typically plans the restarting of the McCully field production to coincide with the North American heating season (generally considered to be November 1 to March 31) when natural gas prices have historically traded at significant premiums at Algonquin City-Gates (AGT), Corridor's natural gas market.

For reference, future natural gas prices at AGT for the 2017/18 heating season prices recently traded at an average of approximately US$7/mmbtu, with prices approximating US$9/mmbtu in January and February 2018.

And the thing is that premium pricing at AGT is not going to end anytime soon. Actually, AGT pricing expects to remain robust to 2023, winter peaks expect to exceed US$8.50/mmbtu and futures market expects the premium AGT winter pricing to continue to at least 2023, as shown below:

Source: Corridor's presentation

The key reasons for this premium pricing over the next years are shown below:

Source: Corridor's presentation

Specifically:

1) Corridor's production is connected to Maritimes and Northeast Pipeline and the Maritime's primary gas supply has historically been sourced from Sable Island and since 2013, Deep Panuke. There is typically a shortage of natural gas supply capacity for the winter months and no new major pipeline expansions are anticipated in the area.

2) Sable Island is reaching economic limit rapidly and decommissioning is expected to begin in 2018, while Deep Panuke has been experiencing production issues and may not last much longer. These developments will exacerbate the shortfall.

On top of that, as part of its optimization strategy and to mitigate the risks associated with the volatility of natural gas prices, Corridor has been pursuing a wise hedging strategy over the last years and will continue its successful hedging strategy from March 2017 to March 2018. Specifically:

Subsequent to quarter end, on April 11, 2017, Corridor entered into a financial hedge for the period from December 1, 2017 to March 31, 2018 for 2,500 mmbtu per day of natural gas production (approximately 2.3 mmscf per day) at a fixed price of $US7.40/mmbtu."

The New Starting Point Proforma The Settlement

In January 2017, the Québec Government announced its decision to support the designation of Anticosti Island as a UNESCO World Heritage site. If designated as a UNESCO World Heritage site, the Anticosti Joint Venture would not be permitted to engage in development or production of oil and gas on the Island.

In April 2017, Corridor, together with other partners of Anticosti Hydrocarbons L.P. entered into negotiations with the Government of Québec with the goal of terminating the exploration joint venture project on Anticosti Island. The Anticosti joint venture is a limited partnership formed in 2014 between Corridor, Ressources Québec Inc., a subsidiary of Investissement Québec (an affiliate of the Government of Québec), Pétrolia Inc. and Saint-Aubin E&P Québec Inc.

Last week, Corridor announced a settlement with the Government of Quebec, as below:

Pursuant to the settlement agreement, Corridor has agreed to proceed with the cessation of all hydrocarbon exploration activities on Anticosti Island, and to cooperate with the Government of Québec in giving effect to the cessation of all such exploration activities. In consideration for, amongst other things, the prejudice suffered by Corridor in connection with its interests in Anticosti Hydrocarbons L.P., the Government of Quebec has agreed to pay C$19.5 million to Corridor. The Government of Québec has also agreed to reimburse Corridor for any further amounts expended prior to its departure from Anticosti Island, and to assume all abandonment and reclamation obligations of Corridor in respect of three Anticosti wells in which Corridor has an interest outside of Anticosti Hydrocarbons L.P."

Thanks to the aforementioned cash injection of C$19.5 million, Corridor's cash and working capital surplus jumped to C$50 million and C$53 million, respectively, which means that the Enterprise Value is ZERO at C$0.60/share, based on 88.6 million outstanding shares.

In other words, the new starting point proforma the settlement with the Government of Quebec is C$0.60/share, based on 88.6 million outstanding shares.

The New Starting Point, The Existing Business And The Free Cash Flow

As explained in the previous paragraph, Corridor's Enterprise Value is ZERO at C$0.60/share proforma the settlement with the Government of Quebec, based on 88.6 million outstanding shares.

And the key thing is that Corridor does NOT burn cash. In contrast, Corridor has a proven and producing asset that requires low CapEx while consistently generating significant profit and free cash flow over the last years.

Actually, the existing producing asset in the McCully field in New Brunswick is a cash flow machine that has been generating at least C$4 million free cash flow over the last years, thanks also to the company's optimization strategy. Specifically:

1) For the period from April 1, 2016 to March 31, 2017, operating cash flow and free cash flow were C$4.6 million and C$4.1 million respectively, while the company generated a top decile of C$34.20 per boe.

2) In 2015, annual operating cash flow and free cash flow were C$6.7 million and almost C$6 million respectively, while the company generated a top decile of C$27.37 per boe.

As a result, Corridor's working capital surplus will continue to increase in the coming years. And thanks to estimated free cash flow of C$4 million for the period from April 2017 to March 2018, Corridor's working capital surplus will reach and/or exceed C$57 million in March 2018.

In other words, Corridor's Enterprise Value at C$0.64/share will be ZERO in March 2018, thanks to the free cash flow from the existing proven business in the McCully field in New Brunswick alone.

And the good news doesn't end here. Corridor's RLI for Proved Developed Producing reserves is 21 years.

Yes, you read this correctly. This is 21 years and we talk for Proved Developed Producing reserves alone, as shown below:

Source: Corridor's presentation

Again, this is NOT proved and probable reserves but we focus on the Proved Developed Producing reserves alone.

In other words, Corridor will continue to generate significant free cash flow annually from its existing business in the McCully field while consistently increasing its working capital surplus for many years to come.

Reserves And Valuation

Corridor currently has natural gas reserves in the McCully Field near Sussex, New Brunswick. And it must be noted that:

1) GLJ assessed Corridor's reserves in its report dated March 1, 2017, and effective as at December 31, 2016, based on the New Brunswick Government's announcement on May 27, 2016, regarding its decision to continue the moratorium on hydraulic fracturing for an indefinite period.

In other words, GLJ assessed Corridor's reserves in its report dated March 1, 2017, and effective as at December 31, 2016, WITHOUT including any reserves associated with Corridor's undeveloped wells (i.e. unconventional wells in the Frederick Brook shale) that require hydraulic fracture stimulations.

To say it differently, the values below have been solely based on the existing production from the conventional tight sandstone reservoirs (Hiram Brook formation) in the McCully field in New Brunswick.

2) I assign Zero value to Corridor's other assets (i.e., Old Harry, Frederick Brook shale) that will be presented in detail in the next paragraph.

That said, let's take a look at the table below:

PDP Reserves Discounted At 10% (C$ million) (Pre-Tax)

43.3

Undeveloped Land (C$ million)

-

Working Capital Surplus Pro-Forma The Settlement (C$ million)

53

Shares Outstanding

88,655,299

Net Asset Value Per Share (C$)

1.09

and below:

2P Reserves Discounted At 10% (C$ million) (Pre-Tax)

54.1

Undeveloped Land (C$ million)

-

Working Capital Surplus Pro-Forma The Settlement (C$ million)

53

Shares Outstanding

88,655,299

Net Asset Value Per Share (C$)

1.21

After all, it's clear that:

1) 90% of Corridor’s NAV is in the Proved Developed Producing Category, which is really unique in the energy patch in North America.

2) This debt-free and cash-rich company currently trades at a price which is just 50% its NAV, based on Proved Developed Producing discounted at 10% Before Tax (PDP BT-10) alone. If this is not absurd undervaluation, I don't know what it is.

The Other Assets For Potential Additional Upside

1) Old Harry: This is an offshore conventional hydrocarbon prospect in the Gulf of St. Lawrence that belongs to Quebec and Newfoundland/Labrador. It is one of the largest undrilled geological structures in Eastern Canada and has the potential to contain significant hydrocarbon resources.

Petroleum system modeling completed by Corridor shows that Old Harry has the potential to contain light oil (45-56 API gravity) and/or natural gas. Several direct hydrocarbon indicators support the presence of hydrocarbons including: satellite seepage slicks, frequency anomalies, amplitude anomalies, and AVO anomalies.

The Quebec portion of the Old Harry license currently is under moratorium, but the Canada-Newfoundland & Labrador Offshore Petroleum Board issued in January 2017 exploration license EL-1153 to Corridor in exchange for the surrender of exploration license EL-1105 covering the Old Harry Prospect in the Gulf of St. Lawrence. The new exploration license expires on January 14, 2020, subject to extension by Corridor for an additional one year period (January 14, 2021) with the payment of a C$1 million deposit, as quoted below:

Corridor Resources Inc. is pleased to report that, on January 15, 2017, the Canada-Newfoundland and Labrador Offshore Petroleum Board ("C-NLOPB") issued exploration license EL-1153 to Corridor in exchange for the surrender of exploration license EL-1105 covering the Old Harry Prospect in the Gulf of St. Lawrence. The new exploration license expires on January 14, 2020, subject to extension by Corridor for an additional one year period (January 14, 2021) with the payment of a C$1 million deposit."

Corridor intends to purchase a user license for a Controlled Source Electro Magnetic (CSEM) data program over the Newfoundland and Labrador side of the Old Harry prospect on EL-1153. CSEM data is a marine geophysical tool developed in recent years to investigate the resistivity of geological prospects, similar to resistivity logging in well bores of potential hydrocarbon zones. Highly resistive layers in a geological structure measured with CSEM technology could indicate hydrocarbon bearing reservoirs and, therefore, would serve to reduce exploration risk and increase the likelihood of finding commercial quantities of hydrocarbons. The undertaking of the CSEM program over the Old Harry prospect is planned to take place for a seven-day period in the fall of 2017.

If the CSEM results are positive, Corridor aims to increase efforts to secure a joint venture partner to drill an exploratory well (as of April 2017, estimated at ~US$45 million).

2) Frederick Brook shale: This is a shale gas prospect in New Brunswick which is currently under a hydraulic fracturing moratorium, as shown below:

Source: Corridor's presentation

Thirteen wells have been drilled into the Frederick Brook shale to date, with depth to top Frederick Brook ranging from 1,600 to 4,000 m.

________________________________________________

Author update, 8/8/17

Among other positive indications:

A) These wells have a very flat production curve. For instance, F-58 has a 2% decline rate and Corridor expects F-58 will produce for OVER 20 years, according to Sedar filings.

B) The Frederick Brook shale reminds me of the Permian Basin thanks to its multiple stacked pay zones (6 zones), according to the excerpt below from Corridor's report:

" In 2014, Corridor conducted a well re-entry and fracturing program to further evaluate the shale gas potential of the Frederick Brook shale. The results of the program demonstrated that the Frederick Brook shale is productive from AT LEAST 6 DIFFERENT sub-intervals across a distance of 25 kilometers, with four of these wells currently on production."

_________________________________________________

Corridor will work towards removal of the hydraulic fracturing moratorium, seeking opportunities for joint ventures for the Frederick Brook Shale.

Another Catalyst For Potential Additional Upside

There is one more catalyst that must not go unnoticed. Petrolia (OTC:PTOAF) announced a few weeks ago that it entered into a definitive agreement with Pieridae Energy Limited, a private Canadian corporation, providing for a business combination by way of plan of arrangement pursuant to which Pétrolia and Pieridae will amalgamate to form a new entity to be named "Pieridae Energy Limited."

According also to the previous link:

With its first acquisition of resources in New Brunswick, to this merger with Pétrolia, Pieridae seeks to build a long term portfolio of natural gas to supply the Goldboro LNG Project."

The Goldboro LNG Project is located at the Atlantic Ocean coast, approximately two kilometres from the communities of Goldboro in the west, and Drum Head in the east in Goldboro, Guysburough County, Nova Scotia. The Goldboro LNG Project is the only project on the East coast of Canada that has both key permits for its current stage of development and a credit worthy offtake customer.

Proforma the deal, Pieridae Energy will become a fully integrated energy company, from upstream production to the sale of liquefied natural gas from Pieridae's Goldboro LNG facility project.

The key thing is that no matter what happens with Petrolia and Pieridae, Corridor could be a takeover target for Pieridae because:

1) As quoted above, Pieridae Energy states that:

"With its first acquisition of resources in New Brunswick,......"

This implies that more deals in New Brunswick will most likely follow in the coming months. And Corridor's main producing asset (the McCully field) is located in New Brunswick.

2) Petrolia owns 4 million acres in Quebec BUT this is uncharted land, as quoted below:

Since the Company is still at the exploration stage for all its oil and gas properties, including the investment in Anticosti Hydrocarbons L.P., it has yet to determine whether its oil and gas properties contain economically feasible reserves. Accordingly, the Company does not expect to generate significant revenues from its properties over the next twelve months. In addition to ongoing working capital requirements, the Company must secure sufficient funding to meet its existing obligations and commitments under exploration and evaluation programs and pay general and administrative expenses. Management considers it does not have adequate financial resources to meet the Company’s obligations and anticipated expenditures through to March 31, 2018. Therefore, there is material uncertainty related to events and conditions that cast significant doubt upon the Company’s ability to continue as a going concern."

As a result, Petrolia currently is unable to provide Pieridae with the resources required to support Pieridae's LNG operations.

More importantly, nobody also can guess whether Petrolia will ever get to the point to discover the necessary resources for the operational stability of the LNG plant and therefore, the operational efficiency of the LNG plant is highly questionable based on Petrolia's assets.

3) Corridor’s undeveloped assets are uniquely situated to capture this LNG-related market opportunity in Nova Scotia. Specifically:

A) Corridor has a proven and producing asset in New Brunswick with tremendous upside potential, thanks to the undeveloped acreage of 195,000 net acres that includes the Frederick Brook Shale, as presented in the previous paragraph.

B) Newfoundland & Labrador's Government has always been friendly to the energy business and as a result, it recently renewed Corridor's exploration license for the Old Harry project until 2021.

High Insider ownership

Currently, the company's directors own approximately 3.1 million shares. The principal holders with more than 10% of the voting rights attached to the common shares are The Children's Investment Fund Management LLP and Lloyd I. Miller, III, who own approximately 17.2 million shares and 10.4 million shares, respectively.

Therefore, the aforementioned shareholders currently own approximately 30.7 million shares or 35%.

Takeaway

To me, Corridor Resources is a truly unique investment idea. And it's not just about its conservative management team. This is a debt-free and cash-rich company with negative Enterprise Value at the current price of C$0.56/share (Toronto).

On top of that:

1) The Enterprise Value is zero at C$0.60/share (Toronto).

2) Corridor has a stellar balance sheet coupled with proven producing assets that will continue to generate significant annual free cash flow while consistently increasing the working capital surplus in the foreseeable future. Thanks to the free cash flow that will be generated in the coming three quarters, it's conservatively estimated that Corridor's Enterprise Value will become zero at C$0.64/share (Toronto) in March 2018.

3) From a reserves standpoint, 90% of Corridor’s NAV is in the Proved Developed Producing Category, which is really unique in the energy patch in North America. And Corridor currently trades at just 50% its NAV based on Proved Developed Producing reserves discounted at 10% Before Tax (PDP BT-10) alone, although it's debt-free and cash-rich.

4) The other assets (i.e. Old Harry, Frederick Brook shale) are coming for free.

5) A buyout from Pieridae Energy is not out of the question.

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Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Value Digger does not accept any liability for any loss or damage whatsoever caused in reliance upon such information. Investors are advised that the material contained herein should be used solely for informational purposes. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.

Disclosure: I am/we are long CDDRF. 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.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.