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Scaling back on Rock Energy

Third short post summarizing some recent portfolio moves.  First two are here and here.

Thoughts on Rock

Every once in a while you luck out and get in just ahead of the crowd. It doesn’t happen very often; usually you have to wait months before an idea begins to play out (ie. my extended comatose with Extendicare).  So when it does happen quickly, you have to enjoy it.

I first bought Rock back in August in the $1.60’s. I added to it in the $1.80’s and again in the $1.90’s. Two months later its sitting at $3.35 and has been as high as $3.70. That’s quite a move.

Nevertheless, the biggest thing that has happened to the stock between then and now are people waking up to it being cheap (I am told that Keith Schaefer for one, a newsletter writer, has apparently said some positive things about the stock).  And that gives me pause.

That isn’t to say news hasn’t helped.  The current production estimate announced October 15th  was positive, the production growth from 3,500boe/d August 6th to 3,900boe/d is great. But I didn’t think the Viking result, which seems to have been a big catalyst according to some, was all that great. If I remember correctly from my analysis of Novus, a 40bbl/d IP is on the low end of the Viking type curve. Heck, Rock is trading at the same multiple that Novus sold at; which begs the question: what has changed?

While I haven’t gone through the math based on the new production numbers, I’m pretty sure Rock is trading somewhere in the neighborhood of 4.5x to 5x EV/EBITDA.  This is not particularly expensive, but also not nearly as cheap as it was.

There are some stocks that I add to even after they have gone up significantly.  YRC Worldwide for example; I added at $9 after it had moved from $6.  My rationale in that case was that the company had an extremely wide range of possible valuations.  Depending on whether you wanted to view the future pessimistically or optimistically you could come up with reasons that justified anything from $0 to $30 per share (as an off-topic note, the same logic goes the other way, which is why I’m not touching YRC Worldwide even as its fallen below $12).

But Rock Energy does not seem to me like one of those stocks.  In order to double again from here the stock either has to command a much higher multiple or be able to grow significantly.   I can’t see the former happening as long as their production remains heavy oil.  As for the latter, the company will likely continue to churn out solid growth, but it will take time, and a lot can happen between now and then.  Another burst like we have seen seems unlikely.

Meanwhile, the heavy oil differential has been creeping up and its now at $34/bbl compared to WTI. Rock might be the brightest new light oil player in the basin, but they still generate all their cash flow from the heavy stuff. I still like the company, I like their prospects, but it seemed to be time to take some off the table here. So I did.

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