Disclosure: I am long MAUXF.PK. (More...)
Any stock that trades with a 14% yield usually does so for a reason and Mart Resources (MAUXF.PK) is no different. The company trades on the TSX Venture exchange which has been rightfully pounded, operates in potentially unstable Nigeria, and has one big pipeline problem. In this case, however, I believe that these risks are already priced in and a significant number of positive catalysts are likely to push the stock to new highs this year.
Mart Resources
Closing Price (5/6/2013): $1.44
Mkt Cap: $513 million
Yield: ~14%
(click to enlarge)
History & Management
Mart Resources is an interesting success story. It was one of the first foreign oil companies to partner with Nigerian companies under an indigenous and marginal fields program. Mart and its partners, Midwestern Oil & Gas and Suntrust Oil, are developing the Umusadege Oil Field in the Niger Delta area of Nigeria. Production at the onshore field started in 2008 and has consistently increased ever since. The company has also developed a substantial reserve base that has been consistently increasing.
Unfortunately, this success hasn't come without setbacks. Mart remains dependent on a third party pipeline that has been the source of constant shutdowns and pipeline losses. On top of this, even when fully operational Mart's allocation on the pipeline is insufficient. Corruption in Nigeria remains rampant and there are always questions about the government's ability to crack down on oil theft.
CEO Wade Cherwayko has been active in the industry in West Africa for over two decades and has put together a quality team at Mart. Even after the recent pullback the stock is up about 40% over the last year and nearly 230% over a two-year period. On top of this, shareholders have received $0.25 (17.5% at Friday's closing price of $1.44) in dividends within a one-year period. Management has consistently created shareholder value and demonstrated its willingness to return capital to shareholders.
For those interested here is an interview with the CEO from this past November that gives an overview of the company and the marginal field program.
Marginal Field Program
The marginal field program under which Mart operates was initiated in 2001 with a goal of fueling the growth of independent Nigerian E&P companies. The government allocated the first 24 marginal fields in 2003. These "marginal fields" are fields owned by major international oil companies and the state oil company (NNPC) that have remained non-producing for over 10 years due to marginal economics and high fiscal terms. The program was set up to give improved fiscal terms from the historical 20% royalty and 85% profit tax. Companies receive reduced royalties and a profit tax of 65%. Thanks to the first allocation of these fields Mart is involved in one of the best performing marginal fields in the country.
Umusadege Field Highlights
Mart, Midwestern, and Suntrust re-entered the previously drilled UMU-1 well in June 2007, and commenced production in April 2008. The partners have grown production, reserves, and prospective resources on a consistent basis ever since.
Well Result Highlights:
UMU-1: Re-entered June 2007 and tested 2 of 13 oil bearing sands. These zones flows ~3000 bopd each and has been producing with little decline since April 2008.
UMU-3: Re-entered November 2007. Flowed ~1000 bpd with a high gas/oil ratio and production is suspended.
UMU-4: Drilled December 2006 to a depth of 8,818 feet. Oil was recovered from three quality reservoirs but was suspended for possible future production.
UMU-5: Twin to UMU-1 drilled in March 2009 to produce from two zones encountered in UMU-1. Tested zones at 3200 bopd and 725 bopd and has been producing since.
UMU-6: Completed in October 2010 to a total depth of 9,000 feet. Tested four different zones with initial flow rates of 3100, 3400, 4200 and 3600 bopd and has been producing continuously since December 2010.
UMU-7: Targeted same sands as UMU-6. Tested 2450, 2600, 4000 and 1240 bopd and has been producing since May 2011.
UMU-8: Tested four zones for a combined rate of 7661 and has been producing since October 2011.
UMU-9: Confirmed eastern extension of the field and was a very successful well. The well encountered 430 feet of gross pay in 20 sands including six new sands. Five sands tested produced at 11718 bopd.
UMU-10: Drilled from the same pad as UMU-9. Tested combined rate of 5019 bopd.
UMU-11: The next well to be drilled, expected to spud this Q2 2013.
Growing production has been capped by limited pipeline capacity. Current allocated capacity is about 13000 bopd but the line has been plagued with frequent shutdowns. The company has expanded the processing facility at the field to a capacity of 35000 bopd. The field is capable of producing near this rate and the company plans to ramp up production when the new pipeline is complete.
Under the terms of the RSA Mart funds 100% of capital expenditure and is entitled to 65% of distributable funds until the company has recovered spent capital. Mart receives 50% of remaining funds as Profit Oil, meaning the company receives 82.5% during cost recovery. After full recovery Mart is entitled to 50% of distributable funds.
Exploration Highlights:
- Up to 33 stacked sands
- Oil in shallow sands, oil or gas-condensate in deeper sands
- Geophysical interpretations very similar to the main field
- Proven hydrocarbon system with successful drilling to date
- Continuous sands across field delineation wells expected to continue
Source: Developing Nigerian Assets presentation
Bunkering & Politics
For those who aren't familiar with oil production in the Niger Delta, pipeline losses and downtime are a constant headache. Bunkering, hacking into pipelines to steal oil, costs companies and the government billions in revenue each year. The makeshift refineries and pipeline leaks have done significant environmental damage to the delta. The problem seems to have escalated recently with Nigerian production hitting its lowest level since August 2009. The government has a lot on the line with 80% of revenues and 95% of foreign currency earnings coming from crude production. Whether or not the government has the ability to crackdown on theft remains an open question.
Financial Performance
Mart has a solid balance sheet and over the past few years has eliminated its debt. The company was growing earnings consistently until recent pipeline constraints capped production and long periods of downtime and pipeline losses have further affected financial results. With that said, the company has a strong history of growing earnings and production.
(click to enlarge)
The company continued to be very profitable in 2012 even with 85 shut-in days compared to 50 in 2011. Pipeline losses for the year also spiked to 13.6% from 8.5% in 2011. Even with these challenges cash flow from operations jumped 23.4% to $130.3 million. The company paid $0.20 in dividends and announced a $0.05 quarterly dividend going forward. Using a 10% discount before tax the NPV of Mart's 2P (proved + probable) reserves is approximately $785 million. I believe this will prove well below what is actually in the ground as the consistent drilling success at Umusadege should continue to prove up and add resources.
Highlights from 2012 Annual Results (Source: Company presentation)
Due to a lengthy pipeline shutdown from February 15 until April 17, 2013, Mart's cash position has likely deteriorated somewhat as it paid the dividend (~$18 million) in April as well as ongoing operating costs. The company arranged a $100 million dollar loan facility in March that will provide some flexibility. Mart's capital expenditure for 2013 is estimated to be approximately $75 million, while dividend payments will cost about $70 million. With cash flow from operations and the loan facility the company should be fully funded for the year, and a revision to a more typical number of shut-in days, which I believe likely, would cement this.
Outlook
After surging to an all-time high of $2.27 in February, Mart has pulled back significantly. I believe this can mostly be attributed to three factors:
1. Ongoing pipeline disruptions
The Agip pipeline was down for 53 days in Q4 2012 and 55 days in Q1 2013. This has had a negative impact on results, financial strength and perception.
2. Headline risk and political uncertainty in Nigeria
Conduct a quick search of recent news out of Nigeria and you will see that violence and corruption affect many businesses operating in the country. With sinking crude exports and revenue recent reports have indicated an increase in anti-theft activity by government forces. The success of these actions remains very questionable but the headlines of violence and instability are likely to have contributed to weakness in the share price.
3. Weak oil price and poor performance of the TSX Venture
The TSX Venture Exchange and Canadian junior oil companies like Mart have taken a beating recently. WTI sank from the high 90s in February to mid-80s in April before the recent bounce.
While none of these risks can or should be ignored, I believe that the upcoming catalysts will most likely outweigh them. However, any potential investor must pay constant attention to future developments related to any of these factors, particularly progress with the pipeline and oil theft in Nigeria.
With that said, I believe that these five catalysts will likely push the stock to new highs by the end of the year:
1. New pipeline & subsequent jump in production
Mart and its co-venturers are working with Shell (RDS.A) to build a 54km pipeline that will run to a Shell export pipeline and then to the Forcados export terminal. The pipe is already on the ground in Nigeria and construction is underway. Things often progress at a slower pace in Nigeria but the pipeline is expected to be operational before the end of the year. Upon completion the new line will provide much needed redundancy and should reduce downtime and losses as it is deeper underground and encased in concrete.
Source: Company presentation
Source: Bing Maps
The Shell export pipeline is shorter and passes just south of the oil city of Warri through more populated areas and, in my opinion, is likely to prove more consistent than the Agip pipeline. At this point the performance of the new pipeline remains an unknown, however, it is a near certainty that a second export option will bring much needed diversity to the company and consistency to operating results. Under its current agreement Mart is allocated only about 13000 bopd on the Agip line. Total allocated capacity upon completion of the new pipe will be near 40000 bopd. This represents a massive increase. Fortunately, we already know that the oil is in the ground and the Umusadege Field can support this volume.
2. Continued sustainability of the dividend
When the Agip pipeline is operational the company can easily support the current quarterly dividend of $0.05 with a modest payout ratio. However, the significant downtime these past two quarters (53 days in Q4 2012 and 55 days in Q1 2013) has left legitimate unanswered questions for investors. The company remains financially strong with no debt and as of year-end had $43.4 million in cash, although this has likely decreased due to ongoing operations and the April dividend payment. At the end of March the company arranged a $100 million secure term loan that is intended to fund capital expenditures and further development, which should provide a bit more breathing room. Lastly, as of April 17 pipeline maintenance and repairs have been completed and oil has been flowing ever since. With the current yield of 14% the market is pricing in a high probability of a dividend cut. However, I believe that due to Mart's strong balance sheet and financial strength, combined with the recent resumption of production, this will not occur.
3. Lower pipeline downtime following an unusually weak period
While less downtime should obviously result from the completion of the new pipeline, in the short term there is reason to believe the worst may be over. The recent downtime is not a new phenomenon and historically long periods of major maintenance, mostly a result of pipeline vandalism and bunkering, have been followed by periods of better performance. Recent reports have indicated an increase in both violence and oil theft as well as a government crackdown. The impact of these actions is yet to be determined and any potential investor should follow developments closely. Looking at historical shut-in days it becomes clear that the recent downtime is more likely to be a periodic occurrence than the norm. I believe it is unlikely that pipeline downtime continues at the rate of the past two quarters and as such improved results will help carry the company until the new line is operational.
4. Continued drilling success at the Umusadege Field
Final test results from UMU-10 are pending. The next well to be drilled, UMU-11, is from the same surface location as UMU-9 and UMU-10 and will target sands which had a combined 79 feet of oil pay in UMU-10. UMU-11 is expected to spud during Q2. Mart will also be drilling horizontal wells to develop shallow oil reservoirs in the main body of the field. The company is looking at adding a second drilling rig for the horizontal wells. Mart has consistently increased both production capacity and reserves and I expect the drilling success to continue this year.
5. Possibility of acquiring new marginal fields
The Nigerian government has identified over 130 marginal fields some of which are likely to be allocated in the near term. Mart has repeatedly stated that it will secure interest in any new marginal fields allocated by the Nigerian government and is very well positioned to do so. This would diversify Mart's asset base and could provide significant upside. The Umusadege field and the completion of the new pipeline should provide Mart the financial resources necessary to develop any new fields without dilutive financing. Also, the company will continue to operate under the indigenous program that provides benefits and reduced taxes on any new marginal fields.
Conclusion
After being offline from February 24 until April 17, 2013 the Agip export pipeline is back up. The dividend appears secure in the near term. The stock is trading near a strong level of support ~$1.40. If this support holds investors will be paid 14% annually to wait for the new pipeline to be complete. Completion of the pipeline should be transformational for the company reducing downtime and approximately doubling production and sales. Management has proven to be shareholder friendly and has suggested further dividend increases. They have also proven to be an effective operator in Nigeria and are perfectly positioned to take advantage of further marginal field allocations. I believe shares could double by the end of the year if the company executes its strategy effectively and on time. In the low $1.40s I see limited downside for investors who are committed to actively following progress and developments in Nigeria, making this a very favorable risk-reward scenario.