I've been trying to work out how I feel about the latest news.
It's taken me a little while to work it out, but I think I see
things quite positively -
I was initially a little disappointed by the latest numbers,
especially as they had been rushed out (early by 3weeks!) why?
It seemed to me that they were early for a reason? Fortunately
we didn't have long to wait to find out - today's fund-raising
announcement quickly clarified things.
So, what about the numbers. Well, production was down about 9%
(Q2 vs Q1). Not too good, but probably not too worrying. The
company has been managing it's finances so well that it was
bound to have suffered some production hits. (The company has
been significantly cash flow positive even during the worst of
the poor pricing, and some of this was bound to happen at the
cost of drilling or over-stressing output). A part of the
NG reduction is certainly due to decline - especially in the
chalk field where we all know things blow big and die.
However, I also think it quite likely that SFY might have
scheduled some well work for the quarter.
Another consideration is that in Q4/Q1 SFY were highly motivated
to pump - i.e. in the lowest of the pricing environment they
probably opened all the stops to get cash. As such, comparisons
with Q2 are probably not too significant. Remember that year
on year the production is significantly up. This is largely
due to the Sonat acquisition. However, this happened under
extreme circumstances - the same reasons that made it a cheap buy,
also make it impossible for us to know what it's "natural"
production rates would have been if circumstances had been normal.
Now, the above is speculation, and if there is a conference call,
or if anyone wants to call the company, it would make good sense
to try to establish the real reasons for the reduction. I suspect
they'll turn out to be some combination of the above - decline,
maintenance and extreme output in Q4/Q1.
The other thing which disappointed me with the results was the
production pricing they got. However, this is more of a problem
with my hopes - largely based on watching the futures market!
It was all to easy to project the futures numbers that we've
seen in the last few weeks back over the entire quarter as if
they'd always been there. I tried to reduce them, but is was
too easy to forget that at the start of the quarter, oil had
only just started its rise. They made 20c, based on an average
selling price of $2.23. Based on today's prices, their average
price would be around $2.50. If we re-run the quarter with
these prices, EPS gets up close to 40c. This surely is a big
positive going forward.
Finally, another big positive was the cash. Last quarter they had
EBITDA of nearly $16m, and they stated they had paid down debt in
the quarter by $4.4m. This quarter they have had EBITDA of $18.6m
which suggests that they have made a far bigger debt pay-down.
Any assertions here that they are struggling under debt loads
doesn't add up. Furthermore, if we re-run the quarter at today's
prices then EBITDA goes up to around $21.5m - very nice.
With regard to the announcement today, I think actually this is a
positive. One of the big problems with the shelf registration of
a couple of weeks ago was the uncertainty it created. How much
dilution would we incur? Well today we know it's going to be 25%.
I don't think that's going to be too bad.
History lesson - SFY have increased their number of shares at an
average rate of 12.8% per annum (average over the last 10 years).
They haven't made any increases since 1996 apart from the 10%
stock dividend that they made in October 1997. In fact, if you
take out the TWO 10% stock dividends that they have done in the
last 10 years, then each shareholder has been diluted at a rate
of around 10.6% per annum (compound). In this context, the 25%
increase just announced simply puts us back on trend.
Now, in case anyone is worried about the dilutative effect of
all these increases, it is worth pointing out that the money raised
has been put to consistently good use. Over the same 10 year
period, the company has grown reserves and output at an average
rate of more than 41%. The net result is that even after the
share dilution, the company has grown reserves and output at an
average compound rate per shareholder interest of >30%.
In this context, I think I am happy for the company to raise
this money and put it to good use in increasing output and
earnings.
A final comment about the financing. The company must be
pretty confident about its future ability to generate cash.
The fundraising will generate about $170m in cash. However,
only about $45m of this will come from equity - the biggest
chunk ($125m) is going to be debt. This debt requires
interest payments, which have to come from future cash flow.
However given that the company has high levels of proved
reserves - i.e. >400Bcfe - which have a current production
value of >$1Bn, it doesn't seem likely that they'll be
short of cashflow! (Part of the raised cash will presumably
be used to make some of these reserves producing, whilst the
rest will presumably be used to continue to grow their
reserves further).
Finally, with regard to the movement in the stock price today,
guess that I'm not surprised. Firstly, for all practical purposes
the company "missed" it's target. Of course, these targets
were only established in the last few weeks, and the company
actually hit the targets of a few weeks ago. (Guess the analysts
can't have had much contact with the company in the last few
weeks, coz you'd expect them to become more accurate, not less!)
A couple of months back we'd have been delighted with 20cents!
Anyway, the "miss" set the tone for the day. Together with
the second (financing) announcement, it gave the market a lot
to chew on. The net result? A day without significant volume
and a minimal price movement (on a day when most O&G stocks
sold off anyway).
This stock is an easy target for shorts - it's got a naturally
volatile stock price, has a smallish capitalisation, and most
of the stock is in the hands of institutions. This leaves
the shorts and market maker to have a field day everytime there
is any minor excuse. In this context, today didn't seem to
be such a big deal.
So what about the future?
Well, it looks as if oil is going to stay at a good price.
It also looks as if SFY will get their cash to increase their
drilling - and at a time of low drilling costs too. Furthermore,
given that they are on the point of raising funds, I'd expect a
few positive news items in the next week or so, just to help
things along a little.....
It doesn't sound as if the fund raising is that far away.
Presumably the Q's figures were rushed through to support it.
On that basis, it would seem likely that we could get an
underwriters agreement in the next few days (it may already
be in place). This is important, because it means that SFY
can probably already start to commit some of the money -
i.e. they could very soon be doing some serious drilling.
That would be a big plus. Given the delay between starting
to drill, and getting production, the sooner they start,
the more likely they are to have a significant increase in
output for Q4 and Q1 (which will likely be the strongest
pricing quarters over the next year). Another big positive.
By the time that we get the next quarter's announcements,
which, barring a complete crash in commodity prices, will also
give us good earnings, the company will be four quarters past
the "paper loss" of Q3 last year. We will then again have
a positive trailing twelve month EPS, and we'll get a PE
number again! It will then be a LOT easier for any potential
purchaser to look at the historic and future PER's and see
the growth (and the value). This will also help the stock
price along.
So, I think there's much upside to come. Because of the
stock dilution, I'm going to reduce my earnings target a
little for this year - I'll now say $0.90 (down from $1).
This is totally due to the 25% dilution on Q3 & Q4 EPS
with some upside due to Q4 production increases.
However, I'll still hazard that we'll make >$1.50 next
year, even after dilution, because output should be up
significantly. Perhaps we'll still get to my $20 May
target.....
All things considered, I think things still look quite
reasonable.
Mark |
