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How to Find and Play the 10-Baggers Abroad – Part 1

|Includes: XCite Energy Ltd. (XCTGF)


What were the oil stocks that made me the biggest profits in 2010?

It was junior oil stocks with international plays.  Companies like Xcite Energy (XEL-TSXv) that went from 62 cents to $6 last year with a heavy oil play in the North Sea, or TAG Oil developing their New Zealand asset, moving from $2 – $6.  The one big international stock I missed was TransGlobe (TGL-TSX) which went from $3.50 – $20 on drilling success in Yemen and Egypt.

These junior international plays are often orphaned stocks with big, high-impact exploration plays – and if they hit WHOOSH! The stock can flow upwards like oil gushing out of a well.

But if they miss…ouch.   The investment can be a big win, or a big loss.  These international exploration plays are what I call a one-decision stock, or a widows-and-orphans stock (nobody gets out alive) or a binary trade – it’s a 1 or a 0.

They have several key differences from the home grown North American oil plays.  If investors know what they are, and how to “game” them, they have a much better opportunity at making a profit – whether the well is a gusher or dry.

The three obvious differences is that international plays can have:

1. more political risk that warrants a lower valuation

2. a much bigger prize (bigger well) if they hit,

3. more risk geologically compared to domestic ones, and I’ll explain why.

First, though, understand that North American plays are now dominated by shale or “tight” oil plays, like the Bakken or Cardium plays, or the US shale gas plays.  In shale oil plays in North America like the Bakken, a really good well might have an IP rate of just over 3000 bopd – but in Canada the best wells are more like 500-600 bopd.

But in countries like Colombia companies like Petrominerales are often hitting 6,000, 10,000 and 15,000 bopd wells.  The value of your investment is obviously going a lot higher with those bigger wells.

And the international arena is full of countries just opening up to new levels of investment in oil and gas and investors can expect this trend of big new discoveries to continue – onshore and offshore.

North America is a mature enough basin that all the juicy profitable low hanging fruit is gone, and can’t compete with those production numbers.

The other factor that gives (successful) international plays much more profit potential has to do with risk and valuation.

Domestic plays have become denominated by the “Resource Play” which is a large acreage of “tight” oil, or is an “unconventional” play that can hold a large number of low risk wells with highly repeatable results.

With 3D seismic and other exploration tools, investors have become accustomed to companies drilling successfully 80%, 90% or 95% of the time.

This safety factor means that companies with domestic plays can extract higher valuations from the market when they get financed – at a higher percentage of the company’s Net Asset Value, or NAV.  So not only is the upside capped on domestic plays by small IP rates, the starting point is higher due to less risk.  So the potential profit window is smaller on domestic plays.

My experience is that most domestic plays get financed between 0.7 – 1.25x NAV.  However, international plays can get financed as low as 0.2 NAV – 0.5 NAV, particularly if they are “orphaned” stocks.

What does that term mean?  It means the company has no active “sponsorship” in the market; no brokerage firm or controlling shareholder is actively promoting the company.  Most retail investors greatly under-appreciate the importance of good sponsorship in a stock.

I will often buy stocks just because the most important investment banker in Calgary or Toronto is firmly behind the company.  Besides premium assets, sponsorship creates premium valuations more than anything in the market. (This is important enough for retail investors to understand that I’ll do a whole story on the “sponsorship” game next week.)

And without it, stocks are orphaned, and can trade at big discounts.  And there are often a lot of international plays that are orphaned.  TAG Oil was orphaned from 15 cents all the way up until GMP raised them $17 million at $2.50 in 2010.  Xcite Energy was orphaned for a long time; no brokerage firm was actively telling the rest of the street – “this is our deal, we financed it, and it’s going to be a big winner”.

And there is truly a very simple way to discover, and play, these high profit potential stocks.  If you’re serious about making money in this highly profitable – but higher risk – sector, it will only mean a little bit of sleuthing.

In my next article, I will explain how I do it, and how you can play them to maximize the opportunity for capital gains.

As an added bonus, I will outline a case study of a current orphaned international play – and a current OGIB portfolio stock – that is expecting results on a high-impact well within 4 weeks, and the valuation of a recent transaction in this area tells me this stock’s valuation could triple if the well is successful.

Lastly, I would say these opportunities are likely to become more difficult to find.  That’s because after the financial crash of 2008, the oilpatch – like everybody else on earth – reduced risk and stopped spending money.  These types of high risk international plays were obviously the first to get canned from exploration budgets.  Enough risk appetite has returned to the market that these high impact international plays are now attracting a lot more mainstream attention sooner than before, and getting in REAL cheap, like I did with Xcite, will be more difficult.

But as long as the international play in your sights is not a recognized resource play, then it should still be trading at a good enough discount to NAV to provide some excellent upside potential.

If they hit.



Disclosure: I am long OTC:XCTGF.

Additional disclosure: long XCTGF.pk and taoif.pk - something is wrong with this instablog page today never had this issue before