Corridor Resources: Canadian Politics, Fracking, And Opportunity

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About: Corridor Resources Inc. (CDDRF)
by: Silver Coast Research

Summary

It's election time in New Brunswick, and Corridor Resources will be hoping for a pro-fracking party to emerge from the current confusion.

The lifting of the moratorium on fracking would be a game-changer for the company.

The risk/reward looks attractive at this point. Our probability-weighted fair value is C$1.025, representing 51% upside from the current price.

Toronto Stock Exchange: CDH

OTC US: OTC:CDDRF

Market cap: C$61m

Corridor Resources ("Corridor") had two potential catalysts going into 2018. The first one was the Old Harry prospect in the Gulf of St Lawrence. Due to a more complex geology than first envisioned, and due to regulatory constraints, Corridor decided in June to put the project on the back burner.

The second catalyst relates to the Frederick Brook shale gas prospect in New Brunswick. The development of the field is currently blocked by a moratorium on fracking. This could change, however, depending on who takes control of the provincial legislature in New Brunswick.

The election that took place on September 24 saw the pro-fracking Progressive Conservatives ("PCs") edge the Liberals (22 seats to 21), but the PCs did not get the 25 seats needed for a majority. The political show will go on for the next few weeks or months, and depending on who comes out on top, the upside potential for Corridor could be significant.

Corridor's share price, as it is, does not price in the possibility of the ban on fracking being lifted, which provides an attractive risk/reward opportunity to investors.

Why The Fracking Moratorium Matters To Corridor

Corridor's current producing wells are located within the McCully field, itself situated within a larger formation, the Frederick Brook shale. Corridor has identified two growth avenues in the area:

  1. additional resources within the McCully field itself, from wells that were not completed due to the moratorium on fracking
  2. a shale gas resource in the Frederick Brook area at large (also undeveloped due to the moratorium)

Corridor Resources Frederick Brook and McCully field map

(Source: Company's presentation)

The current reserves below (amounts in Canadian dollars) pertain to the producing assets of the McCully field only, as they exclude resources that cannot be tapped as long as the moratorium is in place:

Corridor proved and probable reserves (Source: Company's presentation)

If Corridor was able to use hydraulic fracturing, the prospects would be significant. As mentioned above, the company would be able to increase production at the McCully field itself, and, potentially, to develop other parts of the Frederick Brook shale area:

  1. Additional reserves from McCully itself: An evaluation of the resources that could potentially become reserves if the moratorium was lifted, has been performed by GLJ Petroleum Consultants:

    Corridor Resources unrisked resources (Source: Company's presentation)

    The results show significant upside potential for Corridor. In the base case, reserves worth C$74.6m could be added to the current C$63.5m of Proved plus Probable reserves. And this doesn't factor in the potential from Frederick Brook:

    These contingent resources are in addition to the reserves estimated in the McCully Field in New Brunswick in the GLJ Reserves Report and do not include the Frederick Brook shale resources.

    (Source: company's press release)

    Notes:

    - Corridor has approximately C$175 million of tax pools (see table below) available to be applied against future income, so the after-tax NPV is actually the same as the pre-tax one in the company's simulations.

    Corridor tax pools

    (Source: Company's 2017 annual information form)

    - Readers can find more information from the GLJ report in the APPENDIX "A" Statement Of Contingent Resources Data section of Corridor's 2017 annual information form.

  2. Frederick Brook shale: No resource has been quantified at this stage for the shale formation. A number of potential wells, some of which have been successfully tested, could be put into production and connected to the current facilities:

Corridor Resources Frederick Brook Shale

(Source: Company's presentation)

Political Situation: Could The Fracking Ban Be Lifted?

An Inconclusive Election

The provincial election in New Brunswick took place on Monday, September 24. The preliminary results saw the Progressive Conservatives eke out a minority government (22 seats to the Liberals' 21), despite the Liberals winning the popular vote (37.8% to the PCs' 31.9%). The Green Party and the People's Alliance took 3 seats each.

With no party getting the 25 seats required for a majority, there is no clear winner at this point. The Liberals' leader, and current premier, Brian Gallant, feels that he has legitimacy to retain his position:

"I am still the premier, and we are still the government," Gallant told reporters after the meeting. "But … we have heard the message loud and clear from New Brunswickers last night. There's some uncertainty at the moment, and I recognize that."

(Source: CBC)

The parliamentary convention does allow Mr. Gallant to head a minority government as long as he doesn't lose the confidence of the legislature:

Assuming Gallant carries on — parliamentary convention is on his side — he will have to call the legislature before the end of the year, choose a Speaker, present a throne speech and then hold the standard two-week debate on whether the legislature supports that speech.

(Source: CBC)

Of course, the PCs' leader Blaine Higgs, considers that, his party having won the most seats, they are the ones who should form a government:

“I am calling on Brian Gallant to do the honourable thing and recognize that he lost the election,” Higgs said [...] "He does not have a mandate to govern and he is prolonging the inevitable"

(Source: The Globe And Mail)

Given the current stalemate, the outcome will likely be determined by alliances with the Greens and the People's Alliance ("PA"). The PA's leader, Kris Austin, is willing to support a conservative minority government led by the PCs:

People’s Alliance Leader Kris Austin says he has met with Blaine Higgs and has agreed to “provide stability” for a Progressive Conservative minority government for up to 18 months.

(Source: GlobalNews.ca)

Potential lifting of the fracking moratorium

The key for Corridor's shareholders is obviously the potential impact on the fracking ban. The Liberals plan to keep the moratorium in place if re-elected, while the PCs want to let local communities decide whether fracking can take place nearby - the area where Corridor operates is believed to be in favor of lifting the ban. The People's Alliance, for its part, intends to lift the ban.

There will be further talks this week, and a negotiation between the PCs and the Greens is also a possibility. In that case, concessions from the PCs might be made towards maintaining the moratorium.

If the PCs and PA were to take the reins together, though, the chances the ban would be lifted are real.

Corridor Offers An Attractive Risk/Reward

At the current share price of C$0.68 (for the Toronto-listed shares), the upside potential from a potential lifting of the fracking ban is not priced in.

Net cash position almost covers market cap

The current market capitalization of Corridor is C$61m. According to the Q2 2018 report, the company had cash and cash equivalents of C$56.1m and no outstanding debt as of 30, June 2018. This covers the current market cap almost entirely.

It's not as if the current operations of Corridor were loss-making either. An impairment was booked in Q2 following the decision to suspend work on Old Harry, but cash-wise, the current production from the McCully field generated significant amounts:

Corridor Resources cash-flow summary 1H 2018 (Source: Company's Q2 report)

Q3 cash flow may be negative as Corridor focuses its production on the winter months. But from Q4, the 2018/2019 season will again increase the company's cash position. In particular, Corridor took advantage of the favorable environment last winter to secure high prices for its 2018/2019 production, through:

- A forward sale agreement for 2500 mmbtu/d for the period from December 1, 2018 to March 31, 2019 at $US7.40/mmbtu.

- An additional financial hedge at a fixed price of $US7.90/mmbtu for 2,500 mmbtupd of natural gas production for the period from December 1, 2018 to March 31, 2019.

The high prices (compared to Henry Hub standards) may come as a surprise to some readers. They are due to Corridor's advantaged geographic situation. Using the Maritimes & Northeast Pipeline, Corridor serves markets in Canada and the North-East of the US, that both command higher gas prices.

Corridor Resources markets (Source: Company's presentation)

The average price throughout the year is about US$4.5/mmbtu. But Corridor focuses its production on the winter months, when prices rise significantly:

AGT gas pricing (Source: Company's presentation)

With the 2018/2019 winter production partially hedged at high prices, the season should be another successful one for the company. The downside risk in Corridor's shares at their current price seems minimal.

Valuation

Corridor trades at a significant discount to reserves

The producing reserves (which include the McCully field only, as discussed earlier) amount to approximately C$0.71/share. Adding up the cash on hand, this brings Net Asset value per share to $1.35.

Corridor Net Asset Value Per Basic Share

(Source: Company's presentation)

Now, if we include the additional C$74.6m that the company thinks it can unlock if the moratorium was lifted, we get an additional C$0.81 per share (C$74.6/91.9 million shares).

The Total Net Asset value per basic share would be C$2.16. At the current C$0.68, and even accounting for the corporate costs that need to be covered (about C$3m per year) and decommissioning liabilities of C$9.1m, there is scope for significant upside potential in the market cap.

Price target

If the ban is not lifted, the shares will probably keep trading in the C$0.65-C$0.75 range, while we wait for management to put the current cash pile to work. If the ban is lifted and Corridor is able to go ahead with its drilling plans at the McCully field (valued at C$0.81, see above), one can expect the stock to re-rate, with the C$1.20-C$1.50 range a realistic medium-term target. A potential development of the Frederick Brook shale would add further value, but cannot be quantified at this stage.

If we give an equal weight to the two scenarios (memorandum upheld or lifted), our price target would be (0.7*50% + 1.35*50%)/2, equating to C$1.025 per Toronto-listed share (about $0.80/sh for the OTC listing CDDRF). Again, this does not factor in potential upside from the Frederick Brook shale.

It's worth noting that management (who has skin in the game) apparently considers the shares undervalued, as they intend to buy back up to 10% of the public float.

Takeaway

Corridor Resources' shares currently trade at a very conservative valuation, given that cash covers the market cap almost entirely, and current operations can be expected to increase the cash pile.

With the downside well-protected, investors can confidently observe the political show at play in New Brunswick, which, if a coalition favorable to fracking comes to power, could be a game-changer for Corridor.

Corridor currently offers an attractive risk-reward opportunity, even if the full value will be unlocked only when (and if) the ban is lifted.

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.

Additional disclosure: The opinions and views expressed in this article are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.