My Meandering Method for Finding Stocks: Novus Energy

You just never know the path that will lead to an investment idea.

From time to time I get asked what sort of screens I use to come up with ideas. And the truth is, I don’t use much. Sometimes I go to one of those technical analysis sites that lists names that have broken through key technical barriers and I use that as a starting point. So that is something of a method I guess, except that I don’t really pay any attention to the technicals themselves, I use the information as a somewhat randomized starting point, and I am almost as likely to look at a long idea from the ‘break the 52 week low’ bucket as I am from the ‘break the 52 week high’ bucket.

Just as often I use no method at all. I follow a totally inefficient, fairly random path whereby I start with a name that comes up in an article, in a tweet, or that is mentioned on a site, and from there I look at that name and in the process I am usually lead to a few other names, or if I like the theme but not the specific company in question I give some thought and time to search out other names that might be equally leveraged to the idea but more suited to my tastes. I end up bouncing around from company to company and sometimes I find something and more often I don’t.

This must sound terribly inefficient to the more categorical. Why do this?

I have no scientific theory backing me up but my suspicion is that I am more likely to find a name that has been overlooked by others doing this sort of non-method than if I were to follow a specific method that had likely already been thought of and employed by somebody else. So that’s my official answer. The unofficial answer is that its so I don’t get bored. When I don’t know what’s coming next, its pretty easy for me to stay interested and bounce around from idea to idea for a while. If, on the other hand, I regulate myself to studying nothing but bank balance sheets for 3 hours, chances are I’m not going to make it.

What this has to do with Novus Energy

I did not set out with any intent to study Novus Energy. The whole process the led to Novus began with an article on Seeking Alpha describing the circumstantial evidence that Penn West might be getting taken over. I thought it might be interesting to step through the process (as much as I can remember) that led me to Novus.

1. Start with the article on Penn West, which I read because I like the articles by Devonshire and because I know some friends that work at Penn West, so I’m interested in keeping tabs on the company.
2. Read the article, seems like an interesting idea. After a couple of days of thinking about it, I take a small bet on Penn West. Its circumstantial evidence, the former CEO of Canadian Natural leaving his director position at Penn West after buying a bunch of stock, while at the same time Canadian Natural is talking about a takeover. Interesting idea, maybe pans out, maybe not. 1.5% position.
3. Start paying a bit more attention to oil and gas companies and of course, Penn West. Am reading one brokerage report on Penn West and it shows in a table that Lightstream Resources (formerly Petrobakken) is trading at $8 and is going to earn $2 per share in operating cash flow and that is with a much lower oil price assumption than prices today (I think it was around $80 Edmonton Light)
4. Look at Lightstream. Seems cheap historically, maybe not the ideal company (a lot of debt, still questions to me about long term production from horizontal multifrac wells in Swan Hills which is their next big play), but it seems cheap enough to take a stab, so I take a small position there too. 1% this time.
5. Looking at Penn West and Lightstream reminds me of the SeekingAlpha article that Nawar Al Saadi wrote on Longview Oil  – while I can’t access the article I decide to run a spreadsheet with a few quick calculations of valuation. Find out they are at an enterprise value of 70% of the NPV 10 after tax, based on year end 2012 prices and are trading at 4x cash flow, which I note is very cheap compared to what these juniors were going for a couple of years ago.
6. The investigation of Long View doesn’t compel me to buy (at least not yet) but the numbers are cheap enough that it makes me wonder about some of the other smaller juniors. I dig up my old spreadsheet on oil and gas juniors, which I haven’t updated in a year and a half, and use the few remaining names to create the following new table below
7. First company I look at after Long View is Novus. I am surprised the result. Trading at around 2.1x Q1 2013 annualized cash flow? At an enterprise value that is 67% of the year end NPV10 after tax? And the company appears to be in the middle of a strategic review?  This is a company that I have always regarded as one of the higher quality juniors, run by a management team that is respected in the patch.
8. Seems too good to be true. Begin to run through other names to check. No question, the oil and gas junior universe is cheap, but few are as cheap as Novus and those who are usually are so for good reason, either poor management, poor assets, or too much natural gas.

Note that this spreadsheet is entirely work of my own, taken from the financial statements on company’s websites and from their presentations.  In most cases I used Q1 data for recent production but in a few, where that wasn’t available, I used last available or forecast number that came from their presentations.  Unlike the analysts who publish data, I haven’t spent hours going through the spreadsheet to insure that there are no mistakes because I don’t have the time and this is meant to give me a qualitative feel for value more than specific quantitative comparisons, so everything in it should be considered with that in mind.

Strategic Review

I think that the reason that Novus has sold off so much (it was a $1+ stock in January and it had touched as high as 90c multiple times back in May) is because the company is in the process of a strategic review and has been since December.  The process is dragging on and I’m sure there are some shareholders with short-term horizons that are tired of waiting, while would-be buyers are reluctant to put any premium on the company when it appears to be in sales limbo.

I, of course, have no insight into the conclusion of the review, but a perusal of similar transactions suggests that if a suitor can be found, the value of Novus would be significantly higher than what it is trading at.

There is a excellent article on Guru Focus by Canadian Value that details some comparable transactions.  Of particular note is the Long Run Exploration sale of Viking assets for $95,000 per flowing boe.

More recently, and not mentioned in the article, is a smaller disposition of Viking assets by Renegade Petroleum.  On a production basis these assets went for an extremely high $274,000 per flowing boe. Perhaps more representative is the undeveloped acreage metric, on which basis the assets sold for about $1,750 per acre. I’m reluctant to read too far into a direct comparison here, because it is a very small package in comparison with the land held by Novus, so I will only note that Novus has undeveloped acreage of 164,000, of which primarily all of it is in their core Viking area.

One other comparable of note, though not a transaction for the same formation, was completed this week between Pengrowth Energy and Torc Oil and Gas. On Wednesday, Pengrowth announced they disposed of  5,700boe/d of production, 21.3mmboe of reserves (93% oil) in SE Saskatchewan for $82,000 per boe and $24/boe P+P. Now this is from a different formation, and I have read that decline rates on the wells being sold is quite low (I think this is Mississippian light oil production but I’m getting that by reading between the lines of the January 2013 Pengrowth Investors Day presentation and I might be wrong), so maybe there is a premium associated with that, it still provides another data-point that is consistent with the one’s provided by the Guru Focus article.

Finally, the Guru Focus article points to one other Viking producer, Raging River, that is a favorable comparable.  On a flowing boe basis Raging River trades at nearly 3x what Novus does. Similarly, on a net proved plus probable basis, Raging River is valued at $44/boe whereas Novus is valued at $13.44/boe.

Conclusion

Novus is trading at a discount to its peers on most metrics.  Transactions for oil assets are being made for prices that are double what Novus is trading at right now.  A similar valuation for Novus and you get something north of $1.50 per share.  I’m not anticipating that, and I would be happy for a move back over $1, either brought about by a strategic sale or by a strong directional move by management that gives the street some clarity with respect to where the company is going. And as I will write more about in my update this weekend, I think the entire junior/intermediate universe of Canadian oils has been sold off too far, and is due for a reversion to mean.

All and all I feel very comfortable with my position in Novus. It is probably a larger position (6.5%) than I would normally take in a small venture exchange company with limited liquidity (I’ve seen how liquidity dries up for these names if the going were to get really tough), but given what I view as a fairly significant mismatch between price and value and given a number of tail winds I see beginning to form at the company’s back, I feel comfortable with it.