may 7/12 trapezeasset investment letter
Our view is that the companies we own are so far below fair value that, as they continue to add value, they will be difficult for investors to ignore. For example, if in 3 years’ time, Manitok, our largest position has, as we forecast, annual cash flow per share exceeding today’s share price, it is highly unlikely its share price won’t reflect reality.
Manitok Energy
, clearly undervalued, trades at less than half of our appraised value—a value one can easily derive from a cash flow analysis, a net asset value based approach or a private market valuation (what an acquirer would pay for the entire entity).
We value the company today in excess of $3 per share, over twice its share price of $1.40. It just guided to a year-end exit rate of $55 million of cash flow or $.90 per share on approximately 4,000 bbl/d of production which should value it over $4 per share later this year. And then, based on only its existing land holdings, the company is in a position to more than double its production and cash flow over the next 2 years boosting value much further.
So what do we see that others don’t? Well, in the case of Manitok, others may not have seen it at all—the company only came public in late 2010. And it’s a small cap with a market cap of just under $90 million so many institutions might not participate until it is larger because they cannot easily establish a meaningful position. It is the only company participating in its core area and therefore there are no familiar comparables. And, because it’s newer, some may want to see a longer track record prior to investing. Some may not like its high proportion of gas in its booked reserves, though the company expects to be over 60% oil and liquids by year end.
We think our analysis allowed us the advantage of being early—being able to establish a meaningful position at a significant undervaluation. We are indeed attracted to the price discrepancy but mostly to the attributes of the underlying business. Manitok has competitive advantages—an experienced team, mostly former Talisman employees who operated in this locale (the Foothills of Central Alberta) for many years. The economics of cheap land prices and long-life reserves make for very attractive IRRs (internal rates of return) on its mostly oil focused development drilling. Solid value today, and as the company continues to drill one well per month for the next few years, the underlying value should continue to compound and other investors will eventually notice. And, if they don’t, some bargain hunting energy company could bid for it.
Obviously a key risk for Manitok and our other energy holdings is the oil price which, despite growing world demand for energy, could temporarily dip in this unsettled world. We conservatively use only $85 oil (with the industry marginal cost of production above $90) and $2 gas in our analysis. But, we believe being overweight the energy sector is currently warranted because, having performed so poorly, it is the least expensive group, offering a plethora of solid growth companies at extreme discounts to our estimated fair value.