Spartan Energy Corp. (SPE-T) is well-positioned to weather further turbulence in commodity prices, according to Raymond James analyst Jeremy McCrea, initiating coverage of the stock with an "outperform" rating.
"With a low production decline profile (24 per cent) and 1,600-plus identified drilling locations (including its Viking), the company has built themselves a long runway of opportunity with quick payouts of which to recycle capital," he said. "Although we will likely continue to see volatility in commodity prices, we believe a strong balance sheet to protect on the downside and the ability to quickly add additional capex if commodity prices improve, allow investors to have the best of both worlds should future commodity prices remain volatile."
Spartan Energy is the third incarnation of the Calgary-based company, following Spartan Exploration Ltd. (bought out in 2011) and Spartan Oil Corp. (sold to Bonterra Energy Corp. in 2013). Mr. McCrea said investors immediately paid a premium valuation for this iteration.
"Although the company backfilled this valuation with multiple acquisitions in key profitable regions over the past couple years, we believe the negative sentiment on Canadian energy names has clearly also weighed on Spartan Energy," he said.
"Unique to Spartan versus other mid-cap names is its conventional portfolio that, as a rule-of-thumb, should have better porosity and permeability than most resource plays and without the need to frac many of the wells. As a result, conventional pools should provide superior economics. Although conventional plays sometimes lack inventory, the current valuation of Spartan (in terms of what investors are currently paying for future inventory) is remarkably low from a historical perspective and when considering SPE's capability to quickly monetize this land base with funds flow. With much of the inventory with 12-month payouts (which should likely put PPS growth at the higher end of the 10-15 per cent guidance), and a debt-to-cash flow falling to 0.6 times for 2018, we are initiating with an Outperform rating."
He set a price target of $3.75 for the stock. Consensus is $3.96.
"Our valuation methodology is based on a sum-of-parts buildup of PDP [proved developed producing reserves] plus risked upside of undrilled locations using a standard 10-per-cent discount rate and an appropriate rate of development," the analyst said. "Our methodology focuses on companies with the highest marginal profitability, pace of capitalization, and size of opportunity. For marginal profitability, we focus on NPV [net present value] and payback. Wells with the highest NPV and shortest payouts contribute the most to the equity account and can have returns quickly invested back into future wells. Our pace of development estimate is based on the company's reported capital spending for the early years and then assumed exogenously controlling for debt, abandonment liabilities, and a reasonable development program."