Twin Butte Energy Ltd TBTEF

Why I Am Long - Twin Butte

[pm1231]

After some careful analysis and collaboration with those whom I consider experts in this space - I have decided to take an initial position in Twin Butte.  Here is why I am bullish at these prices:

1) Risked NAV seems to be consistent across the board - with a 1x NAV at about $2.50 a share.  Targets set by the analyst community is simply a function of NAV mutiplied by thier weight.   I place little value on analyst targets, but based on thier various methdologies, thier current multiples of 0.87 to 1.3 are currently being applied to thier TBE NAV driving the $2.15 to $3.25 price targets. 

2) Management seems to be proactively transitioning from vertial to horizontal drilling and shifing some capital spending with a focus on relatively lighter oil.  These moves should improve netbacks while alleviating overall declines over the long term.    Also - FX and WTI may exceed current assumptions (see notes below on Iraq situation and medium term outlook on oil price)...currently - FX and WTI far exceed current pricing assumptions baked into managements $201M cashflow projection for 2014.

(From thier Q1 Report

a)  Although the transition away from vertical heavy oil well concentration is ongoing and is showing early success, Twin Butte continues to experience higher than anticipated production declines on a number of its higher productivity vertically drilled heavy oil wells. Ultimate recovery factors in these pools are still anticipated to be on forecast and consistent with other similar pools in the area.  These higher declines are not being experienced on the Company's horizontally drilled heavy oil wells or the Company's Provost are a medium oil production 

b) The Company's expanding operations in Provost have improved the Company's dividend sustainability since the Provost area's production is medium quality oil which, along with lower operating and royalty costs, will generate an operating netback premium of between $15 to $20 per bbl above the Company's Lloydminster heavy oil barrels. 

c) Assuming, for the remainder of 2014, WTI pricing of $97.00 per boe, a US$/Cdn$ exchange ratio of 1.09, and a WTI to WCS heavy differential of $(24.50) per boe, the Company anticipates that its 2014 annual cash flow will be approximately $201 million

3) Net Debt to cashflow is trending to 1.6x for 2014 assuming they stay on target at $201M cashflow for 2014.......very reasonable compared to other intermediates (for example - lightstream - at 2.7x debt and still a 3 month share price increase of 58%).  Even with reduced credit line at 70% draw on current credit - they seem determined to fund growth and dividend sustainability through cashflows. 

4) Very conservative financial discipline - with total payout (debt + capex) just trending below 100% (96-98%) through 2014....with current yield at 10.61%.  (Consider for a moment - if the price recovers to NAV of $2.5 - yield falls back to a normalized level of 7.68% - so for those who argue current yield is a measure of sustainability - it is not (it is simply a function of the current price and market sentiment). 

5) Latest selling over the last few days has been restricted to a handfull of short sellers - concentrated selling between 3 brokers (anonymous shorting 2.7 million shares, First energy shorting 494K, Altacorp at 464k..... with brokerages buying up...TD Securities - 1.1M, State Street 645K, BMO - 580K, CIBC - 455K, ....and 16 other buyers...2 buyers for every 1 short seller...which would appear to be a bullish sign that we are approaching a bottom).

6) Despite active hedging to stablize cashflows at floor prices for heavy oil - TBE stands to benefit over the long term as WTS to WCS differentials shrink with the rollout of rail capacity in the coming years (irrespective of pipeline capacity) - this will allow TBE to access other markets to get a better price for thier heavy oil - which will improve overall netbacks and recycle ratio. 

(from tier Q1 report

a) Approximately 40% of the Company's heavy oil production was sold to rail car accessed markets in the first quarter, enhancing the Company's heavy oil pricing while providing additional marketing options)

6) Seems like ISIS is taking over more cities in Iraq - with the current Nouri al-Maliki helpless to stop the onslaught.  There does not seem to be an end in sight - with ISIS taking over more cities each day.   Not to assert any expertise on geopolitical tensions - but its safe to say sunni and shia have been at odds for quite some time (hundreds of years) - so the current tensions in Iraq do not appear to have any resolution in the near term apart from some "diplomatic" scrambling. My sense is supply concerns will remain for quite some time and speculators are taking advantage driving up WTI. 

g) My read of the US response (articles, etc) also leads me to believe Obama will not tap into strategic oil reserves to offset oil spike - not in the near term. 

h) I suspect - if oil prices remain artificially elevated - the energy patch may experience much better than consensus Q2 and Q3 numbers on all three fronts (WTI prices, FX rates, and WTI differentials).

Conclusions

Given TBE is currently being offered at close to 0.7 of Risked Nav  - this asset is being offered at a 30% discount to NAV with a relatively safe dividend and proactive steps to manage declines through 2014 into 2015...I like the management team - they seem rather conservative with modest growth expectations and solid balance sheet management.  They seem very committed to dividend sustainability even if that means adjusting capex to manage total payout under 100% without incurring additional debt.   Currently - its a buyers market (lots of E&P companies trying to dispose of assets) - and should TBE increase thier Debt/Cashflow ratio to grow accretive production at a good price - it would be a good use of debt at thier current levels. If oil prices remain elevated with improved FX outook - the tailwinds seem to favour TBE in the short term.  

A long winded way of saying the upside at these prices seems to far outweigh further downside risk over the medium term despite the current runup in the energy sector.  I'm buying on the dips and holding long while getting a hefty 10.61% dividend to wait.