Week 55 Update: Arcan Resource

I’ve owned Arcan before, but I have always had trouble holding onto it.  I think that in the aggregate I have probably lost a few dollars on the stock.  Yet here I am again to take another stab at it.

Arcan is an excellent example of why I follow the rules of:

1. Never add to a losing position
2. Do more of what’s working and less of what isn’t

With Arcan, I eventually sold out for good on March 23rd at $4.75.  At the time there wasn’t anything in particular that you could pinpoint that would suggest the stock was about to fall by more than two-thirds.  But what concerned me was that the stock wasn’t doing what it should be doing if things were going well. That is, it wasn’t going up.

And then there was the CAPEX.  My skittishness with Arcan and most other oil juniors has always been based on their level of capital expenditures in relation to their cash flow.   As I outlined in this post back in February, Arcan has been spending multiples more money than its been taking in.  You can’t just keep doing that forever.  It will work as long as the market sees you as a “growth stock”, but as soon as that music stops, well so do your funding sources.

Arcan has gotten themselves in over their head with funding and now they are going to have difficulty meeting their growth expectations.  The near-term outlook for the company is not terribly clear.

So why buy?  Well the stock is off 75% from its highs.  I think its all price in.

As well the company appears to be changing (perhaps by necessity) its spendthrift ways.  President, Doug Penner, said the following in the first quarter press release:

“I am excited about implementing Arcan’s next stage of development.  Having expanded rapidly in our first nine years of operation, we are maturing as a company, ensuring that our continued growth also delivers value for our shareholders over time. We are focused on reducing down‐time, operating costs and G&A expenses as we work to bring our capital spending more in line with our cash flow. We are also looking at all of our assets  strategically, and we will consider divesting non‐core assets as opportunities arise.”

Of course, with reduced spending will come reduced growth, and that is one of the reasons the stock has been decimated.  At $1.50 per share, which is about what it cost me on average to buy a position, we are getting awful close to the value stock territory.  The company has a $7+ NPV of its reserves.   Their production numbers haven’t been stellar, but they are showing stability and they should be getting past the initial flush declines and into more stable exponential declines on most of their wells.  AS well, the company should begin to benefit from the infrastructure spending of the last year, as the pipeline from Ethel brings down operating costs and we begin to see the fruits of the waterflood at Ethel in the second half of this year.   As I pointed out in that same article earlier this year, there is a clear difference between the Ethel decline curves and that of Deer Mountain Unit, where there is waterflood.

Arcan is simply a bet that the stock has gone down too far.  A move back to $2 would be a 35% gain and I could see it happening with nothing more than a bit of improved sentiment.