MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING WEDNESDAY, FEBRUARY 25, 1998 (1)
TOP STORY
Darwin And The Oil Patch
Globe & Mail
As investors are once again cruelly reminded of the fact that the oil and gas business is a cyclical industry, the Darwinian process of selecting winners and losers becomes more crucial with every passing day. In 1996 and most of 1997, looking like a winner was easy -- after all, oil was fetching anywhere from $22 to $26 (U.S.) a barrel. Now that prices have fallen by 40 per cent, however, it's a lot harder to look like a prize specimen.
As year-end reports start coming in from the oil patch, the gap between the leaders and the rest of the herd is becoming more obvious. Some companies with otherwise strong operations have found themselves squeezed in the vise created by falling commodity prices and rising costs, fuelled by last year's explosion of activity. Others are finding their weaknesses can no longer be disguised by strong commodity prices or a robust stock market.
The award for the worst bet of last year, at least in the short term, has to go to the companies that spent billions of dollars on heavy oil assets. This group includes such heavyweights as PanCanadian Petroleum, Gulf Canada and Ranger Oil. Even as they were spending massive amounts to buy production in Alberta's heavy oil region, the price of the commodity was sinking like a rock, putting a brutal squeeze on profit margins.
PanCanadian is laying off 11 per cent of its staff and saw fourth quarter profit drop 43 per cent, with much of that related to its $465-million (Canadian) takeover attempt of CS Resources. Gulf Canada lost the bid for CS and bought Stampeder Explorations instead, paying the hefty price of $688-million. Industry sources say Gulf is now also suffering the consequences by having to shut down production that is uneconomic at current prices.
Ranger Oil chief executive officer Fred Dyment, who spent $566-million for Elan Energy, has said the purchase was a long-term strategic move, and most analysts agree heavy oil will be an important factor in the future. However, they also point out that refining capacity for heavy oil is in short supply -- even with Husky's planned expansion at Lloydminster -- and will be for the next couple of years, meaning weak prices are likely to continue for some time.
As more than one analyst has observed, it's all very well to plan for the long term, but you have to make it through the short term in order to get there. For a company like Ranger, whose share price wasn't exactly setting the market ablaze even when commodity prices were strong, a big bet on heavy oil isn't likely to help matters -- although by depressing the stock further, it could make the company even more of a takeover target.
At this point, companies that are reporting good year-end results can provide some interesting lessons. Amber Energy, for example, is almost totally focused on heavy oil in the Pelican Lake area of Alberta -- that should be bad, right? Amber noted that the price it got for its heavy oil was down 47 per cent last year from 1996. And yet its profit rose 6 per cent, cash flow increased 36 per cent and revenue was up 47 per cent.
One key to Amber's success is that it is growing at a phenomenal rate: its production rose 297 per cent last year. But its costs, which are in the $2.50-a-barrel range, are also among the lowest of any company involved in heavy oil. That means even though it only got $13.26 a barrel for its oil compared with $22.71 last year, Amber is better off than other operators whose costs are closer to $8 a barrel.
The lesson is that if you're going to be in heavy oil for the foreseeable future, you had better make sure that your costs are as low as they can be, since you won't be able to count on a steadily rising oil price to make your balance sheet look good. For that matter, the same lesson applies to the conventional oil-producing sector, since every penny of costs now comes right out of your already wizened profit margin.
Alberta Energy also had good results. It lost $31-million in the fourth quarter as a result of writedowns, but cash flow rose 36 per cent. For the year, profit after onetime items rose 80 per cent, and cash flow was up 32 per cent. Producers like Ranger and Gulf have seen their stock drop 40 per cent from last year, but Alberta Energy's didn't fall nearly as far (about 25 per cent) and is already back where it was before the meltdown began.
Another company getting a lot of interest these days is Poco Petroleums, a senior natural gas producer. The company says 73 per cent of its production is gas, the most exposure of any senior producer. Its revenue for the year rose 35 per cent, cash flow
increased 45 per cent and earnings climbed 70 per cent. Like Alberta Energy, Poco's stock price has already come back to where it was before the oil and gas sector fell off a cliff last fall.
The lesson? If you focused on natural gas last year, when all anyone wanted to hear about was oil, you now look like a genius.
Kerms Commentary: Am I a genius - far from it. But I must admit I have been stressing for over a year now that companies dominant in natural gas was the place to put your investment dollars. Natural gas prices in Canada still remain strong at this point in time. New pipeline capacity is scheduled for November of this year. Prices should fall more in line with what they are in the U.S. It will be interesting to see if the added capacity schedule is realized.
Although I have favored natural gas since I have established my presence here, I am in firm belief that when and if, oil prices fall in the $14.50 to $15.00 range, one should begin to focus on the oil dominant companies. I, for one, will be doing just that. The logic is this. Leverage for the upside may be superior to that of natural gas. We are almost at 10-15 year historic lows. When the price of crude dropped to these levels before, it was only a short stay before prices recovered. The average price of crude over the last ten years is in the $18.00 neighborhood. Just seeing prices getting back to this level will bode well for shares in growing oil dominant companies.
And then, there is the best of both worlds - and probably the best strategy of them all. Look for the companies with production evenly split between oil and gas. I will be screenng companies in this situation, but will be looking for a higher percentage in oil reserves - after factoring out the heavy oil component. As I have been saying for over a year also, heavy oil is not the place to be over the intermediate term.
Let's see how much a genius I turn out to be come next March of 99.
FEATURE STORY
Halliburton Company & Dresser Industries Inc. To Merge
Although the following is US based, the information is impact material. Consolidation in the service sector will be an ongoing trend in 1998. They won't get any larger than this merger. Halliburton has a large presence in Canada.
Halliburton Co. and Dresser Industries Inc., two of the world's four largest oil field services companies, are merging in a $7.7 billion stock swap, the Dallas Morning News reported.
If the proposed deal is completed as intended later this year, the resulting company would carry the Halliburton name and keep its headquarters in Dallas, the newspaper reported, citing one person familiar with the transaction.
The source said the deal was to be announced today.
Together, the companies would employ nearly 100,000 people worldwide and have annual revenue of more than $16.3 billion.
Halliburton and Dresser, which also is based in Dallas, have long histories as competitors in the industry that provides oil field services and products from drill bits to oil rigs.
The new company would vault over New York-based rival Schlumberger Ltd., which had $10.7 billion in net sales in 1997. The other industry giant is Houston based Baker Hughes Inc., which had revenues of $3.7 billion last year.
Dresser had net sales of $7.5 billion in 1997, and Halliburton had $8.8 billion in 1997 revenue.
FEATURE STORY
Bigger May Be Safer In Alberta Oilpatch
Mergers thwart bids by U.S. predators
Calgary Herald
Canadian energy companies will have to get bigger to protect themselves from U.S. predators.
"If you're big today, you're not safe until you're big enough," says Carol Freedenthal, a principal with Houston-based investment banker Jofree Corp., who was in Calgary to participate in the CERI natural gas conference Tuesday.
Because of convergence and deregulation, the energy industry has changed.
"TransCanada still won't be big enough to be safe," said Freedenthal. "I don't think TCPL is through. It is looking."
Last month TransCanada PipeLines Ltd. and Nova Corp. announced their mega-merger.
"As deregulation occurs, there are going to be opportunities for aquisitions for us and for others as well," said TCPL spokesman David Annesley. "This merger allows us to be of the size where we're liable to be an acquisitor a opposed to being acquired."
Freedenthal said all energy companies are looking to grow substantially.
"You're going to have to be big enough to carry the weight in this energy sector," she added. "You're going to have to get bigger and bigger."
And that feeding frenzy in the energy sector could attract suitors from faraway places.
"We'll see partnerships of companies we never dreamed would be together," noted Freedenthal. "There'll be some big energy giants, but they may change their stripes over time."
That means energy companies won't be growing along traditional lines. A company could feed into one energy marketing company which handles generation, transportation and marketing. It could also feed into a communications business.
"It's a challenging business when you start throwing in communication and transportation companies," Freedenthal said. "You're opening a Pandora's box."
Communication companies would play an important role as gatherers of information for energy companies.
A number of U.S. energy companies have telecommunications businesses. They include Alliance pipeline stakeholders Coastal Corp., Enron Corp. and Williams Corp.
"Anybody who has the dollars and looks at the economics can make the decision (to get into the energy sector)," added Freedenthal. In 1996, the energy industry contributed 10.5 per cent to the U.S. gross domestic product, for a value of $7.6 trillion.
"Do we have any boundaries left?" Freedenthal asked. "Any kind of alliance and merger is possible. Now everybody is vulnerable. Nobody is safe."
Wilf Gobert, an analyst with Peters & Co., believes the U.S. market is more ahead in the consolidation of its energy players.
"The degree of deregulation and consolidation may not be as big a factor at present in Canada," Gobert adds.
The only two other large Canadian pipeline companies left, IPL Energy Inc. and Westcoast Energy Inc., are also rumored to be considering a merger.
FEATURE STORY
"No Problem" For Petro-Canada Propane Sale
The Financial Post
Petro-Canada's plan to spin off its retail propane business into an income trust will be well received by investors, analysts said yesterday.
But a senior official with a major competitor said he isn't worried about the change in corporate structure at ICG Propane Inc.
Although slumping oil prices have dulled the bloom on many energy income and royalty funds, the move was applauded by John Tysall, director of corporate ratings at Standard & Poor's Inc.
"I don't think they'll have any problem selling it," he said. "Obviously if they had priced it in 1997, they would have done better."
Propane is not a core business of Petro-Canada, an integrated company that explores, refines and markets oil and natural gas. The selloff will allow management to concentrate on key assets.
"They lose the cash flow from the business per se," Tyson said, "but it takes a long time to generate $250 million," the estimated value of the deal.
A good performance by Superior Propane Inc.'s Income Fund units in the past year will enhance the appeal of Petro-Canada's plan with institutional and retail investors, said an analyst who asked not to be identified.
Superior's fund generated cash of $37.8 million ($1.24 a trust unit) in 1997, 8% higher than forecast in the prospectus for its initial public offering.
Superior is the biggest player in the Canadian market, with about 40%, said Don Baird, vice-president of finance.
ICG has about 30% and becoming an income fund won't change the competitive dynamics, he said. "I honestly cannot see it having any impact on our trust units or our business."
Cost control and growth are expected to boost returns to his unit holders this year by 4› or 5›.
Terms and timing of the proposed transaction have yet to be determined, a Petro-Canada spokesman said. Proceeds will be used for general corporate purposes.
According to a preliminary prospectus filed with securities regulators, RBC Dominion Securities Inc. has been hired as lead underwriter to take ICG public on an instalment basis. Petro-Canada bought ICG in 1990 for $235 million.
FEATURE STORY
Prudential Steel Sees Income Double
The Financial Post
High demand by the Canadian energy industry lifted Prudential Steel Ltd. to record earnings in 1997, with profit almost doubling from the previous year, the company said yesterday.
Net profit soared to $42.8 million ($1.42 a share) on revenue of $352 million, up from $21.6 million (72›) on revenue of $242.9 million in 1996.
High demand for products used by the oil and gas industry, which accounted for 74% of Prudential's shipments last year, was the major reason for the improvement. Total shipments jumped 44% in 1997 to 369,010 tonnes.
FEATURE STORY
Ranger Aims To Build On Modest Profit
The Financial Post
Ranger Oil Ltd. recorded a modest profit in 1997, which president Fred Dyment described yesterday as a year "for building foundations."
The Calgary-based producer, which ran into trouble with shareholders after buying heavy oil specialist Elan Energy Inc. in September, reported a 1997 profit of US$53.8 million (US9› a share), an improvement over its loss of US$14 million (US57›the year before. The 1996 loss reflected a US$71-million writedown of operations in Angola.
Investors pushed up the price of Ranger shares (RGO/TSE, ME) by 5› yesterday to $8.95. Before the Elan purchase, they traded around $13.
The company said its focus this year will be on reducing long-term debt, which rose to US$427 million from US$100 million in 1996 because of the Elan acquisition. Interest charges increased to US$16 million, from US$9 million.
Ranger said its debt to cash flow ratio will fall significantly this year as production from the North Sea and Angola comes on stream.
The Elan acquisition, a 25% increase in North Sea reserves and opportunities in West Africa all position Ranger for continued growth over the next five years, Dyment said.
Revenue in 1997 was US$351 million, up from US$299 million in 1996. Cash flow was US$145.9 million (US$1.38), down from US$189.8 million (US$1.46).
FEATURE STORY
The Financial Post Fourth-Quarter O&G Profit Survey
Oil and gas companies, which racked up growth of a whopping 108% in the third quarter, compared with the previous year, took a tumble in the fourth quarter, slipping 10% compared with the same period in 1996. canoe2.canoe.ca
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