TD Waterhouse likes TOGPrice target $8.50
From today's morning action notes:
TriStar Oil & Gas Ltd.
(TOG-T ) C$5.90
Initiating Coverage on TriStar
Event
Initiating Coverage
Details
TriStar Oil & Gas Ltd. (TOG-T) is the third exploration company started by
Calgary oilman and financier Paul Colborne. Mr. Colborne’s string of
successes started in 1993 with the creation of Startech Energy Inc., followed
by StarPoint Energy Ltd. in 2003, and he now seems set to continue with
TriStar, set up in January 2006.
In each and every corporate iteration, the ‘Colborne strategy’ has focused on a
buy and exploit strategy targeting conventional oil pools with large amounts
of original oil in place (OOIP), typically characterized by relatively low
recovery factors implied to date. The corporate strategy also always focuses
primarily on light and medium quality crude, and almost inevitably translates
into a material asset focus within the Saskatchewan sedimentary basin, due to
its natural bias to light oil reserves. Finally, Mr. Colborne has also come to be
known for growing these exploration companies to the critical mass necessary
for conversion into (or acquisition by) trusts.
In the process, Mr. Colborne has also come to be known for introducing the
markets to management teams that were previously largely unknown; these
teams invariably comprised executive talent that was strong enough to emerge
from previous mid-manager responsibilities to become the driving force
behind the execution of the Colborne strategy in its newest iteration. TriStar is
the third company to roll out a new senior management team as executers of
the strategy. Startech and StarPoint were big successes and clearly, Mr.
Colborne’s hopes to use a proven winning strategy to achieve a hat trick with
TriStar.
Outlook
By focusing on assets with large proven amounts of oil in place, TriStar not
only minimizes geologic or engineering risk, but also provides maximum
leverage to small improvements in either operating costs or recovery factors.
The fact that such improvements can sometimes be made with low capital
requirements, means the strategy provides the potential for spectacular returns
on investment for the company. If we are dealing with a pool with 100 million BOE of reserves in place, a 1% change in recovery factor or 10% change in operating costs can have massive
implications to NPV per share.
Justification of Target Price
TriStar estimates that its reserves as at the end of 2005 were approximately 13.6 million BOE. Based on 45 net
wells that we expect to be drilled in 2006, we would anticipate reserve additions in the order of 3.6 million
BOE, even if we only assume a drilling success rate of 80% (well ahead of this year to date) and assume
100,000 BOE of new reserves per well. After deducting net anticipated production of 985,000 BOE in 2006,
this would suggest an ending reserve estimate in the order of 16.2 million BOE as at the end of the year.
Continuing this methodology through 2007, we expect TriStar to drill approximately 55 net wells. With an
80% success rate and an average of 100,000 BOE per well, it would add 4.4 million BOE of new reserves.
Deducting our forecast production of 1.7 million BOE gives us a potential net reserve addition of 2.7 million,
and a corresponding potential reserve estimate of approximately 18.9 million as at the end of 2007.
Due to the high netback, quick payout, and long RLI nature of the TriStar asset base, we would expect the
company to attract a premium price to the $20 per BOE of reserves metric usually in play with most recent
trust acquisition metrics. If we apply a valuation of $25/BOE to 18.9 million BOE of reserves, the result is an
enterprise value of $472.5 million. After deducting forecast exit debt (and adding back option proceeds of
$14.5 million), we derive an equity value of $8.39 per share, giving us our target price of $8.50.
Key Risks to Target Price – Overall Risk Rating: HIGH
The primary risks to our target price are a continuation of the recent downward bias in crude oil prices, which
could be mitigated by TriStar’s higher than average cash netback, and the relative youth of TriStar’s
management team, in that any operational stumble might be more negatively viewed by investors and result in
downward pressure on the company’s share price.
Risks associated with this target price also include those business risks of the company and industry, including
but not limited to: loss of key employees, drilling success, operating costs, volatile commodity prices, product
supply and demand, government regulations and taxes, exchange rates, interest rates, environmental and
weather concerns.
Investment Conclusion
We are supportive of the ‘Colborne strategy’ in general, and would be more so once it evolves from an
acquisition focus to a drilling focus (as TriStar is doing now). Add to this a strong balance sheet, superior cash
netbacks, quick cycle times/payout of invested capital, and above average leverage to large amounts of light oil
in place, and you have a compelling business model in our view. The recent correction in share price has been
the final piece of the puzzle we were looking for. We initiate coverage with a BUY recommendation and a
$8.50 target price.