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Legacy Oil + Gas (LEG.TO) - Small Cap Value Play


LEG has solid downside protection on a valuation basis, trading at a forward EV/DACF of 4.9x vs. 8.2x for the Junior/Intermediate E&P energy space.LEG trades at less than 50% NAV, and well below its historical forward EV/EBITDA average of 9.5x, at 4.6x right now. Insider buying is substantial, and management has proven its ability to execute, generating double digit CFPS, production/share, and FFO growth on a yoy basis (2011,2012, and 2010,2011). They have done so in a declining CAPEX environment, displaying organic growth that is some of the best in the sector. LEG met its 2012 CAPEX guidance, uncommon in the space. The company has a robust 2.0x recycle ratio and $44.42/boe netback. Operating costs declined 7% yoy. The company is majorly weighted toward light oil and was roughly tracking the commodity but has massively diverged since the beginning of the year.

The issue is debt. The company has 2012, D/CF 1.94x, Debt 462M, CF238m. This is still reasonable in the space which averages 2.0x, however, given lower debt stories are around, I believe investors are looking elsewhere for price appreciation. Further, the company issued $200m unsecured, five year, 7.5% notes with a pension plan late 2012, a decision not prudent given the debt overhang on the stock, but one which they intend to use as a means to reduce borrowings under theircurrent syndicated bank credit facility to further liquidity and flexibility which will overtime help to reduce D/CF, especially if the company can maintain its average 17% CFPS annual growth. Further, management has proven that despite debt they can still produce for shareholders, and have done so consistently since inception without pushing D/CF over 2.0x which is the max in their optimal band (aiming for 1.5x), and again, still well within the average in the sector, but few names with similar debt can attest to the same consistent growth.

A further upside is the company's waterflood efforts which has proven a major lift to the company's reserve life at low cost and a new trend that is attracting interest, and could help the stock as the company continues to refine its efforts.

I expect internal pressure and/or pressure from investors for share value to reflect asset value would lead to prudent management decisions to do so, more specifically ensuring they execute on the reason they brought on 200m in 5yr notes in the first place, which was to reduce their bank facility (LEG has only tapped 54% of the borrowing base, another positive sign for organic growth).

The stock looks bottomed out right now with great value upside to begin chipping away at.