transglobe-energy-it-is-all-about-location-and-cash

TransGlobe Energy: It Is All About Location And Cash

TransGlobe Energy (TGA) is a relatively cheap Egyptian oil producing company that reports in United States dollars. The company has been lumped in with all the latest Canadian challenges despite the fact that most of its production is not Canadian. That mispricing provides an investment opportunity for investors. Egypt has a long history of stability when compared to many of its neighbors. There is a very good chance that the current stability will last for decades. That gives this company an excellent chance to cash in on its lucrative Egyptian production contracts.

Production

There are really no production bottlenecks in Egypt. Nor is midstream takeaway capacity an issue. The Egyptian government has a relatively friendly attitude towards the oil and gas industry because the significant production provides badly needed revenue to the Egyptian government.

Source: TransGlobe Energy May 29, 2019 Press Release

Production is now rising because oil prices are at a level that makes investment in new wells and more production worthwhile. The company still has just received approval to begin development of an area that includes a 3,800 BOED discovery well. Obviously, production will be lower than the initial discovery amount. But development of this sector has the potential to be significant to the company towards the end of the fiscal year and into the next fiscal year.

Meanwhile, the Canadian properties are being explored and developed for their oil potential. The success of this strategy could make these properties a bargain as the previous operator drilled for gas or wet gas. Already the effects of this strategy are becoming apparent.

Profits

The shear oil production growth currently outweighs other considerations because oil is far more profitable than either gas or (in certain cases) natural gas liquids.

Source: TransGlobe Energy First Quarter, 2019, Earnings Report

As shown above, oil production has doubled from the fourth quarter. This will lead to a material profit improvement of the overall production even though total production did not increase.

Source: TransGlobe Energy First Quarter, 2019, Earnings Report

As the Egyptian stability has improved and the government increases its efficiency, the company is realizing some savings. Egypt has long promised more favorable operating contracts and also help for some of the other sticking points. The results are shown above as increased Egyptian operating margins despite the lower pricing of oil.

In Canada, the increasing oil production offset the price decline that the market focused on. The result was one of the better quarters for this company given the prices above. The Canadian production clearly has superior margins and can compete for investment dollars. But takeaway capacity will be an issue restricting development in the near future. Plus, the company does want to plan a superior strategy to develop these leases.

Improving technology has led to a Cardium resurgence. Continuing improvements could keep management very busy on these leases for the foreseeable future. The improving netbacks shown above from lower costs make the purchase a better deal using hindsight.

The Latest

The company actually has better netbacks in Canada than in Egypt.

Source: TransGlobe Energy May, 2019, Investor Presentation

However, as the next one shows indirectly, the Egyptian wells tend to be cheap. They are generally conventional wells that maybe cost $1 million and often less. These conventional wells tend to decline less. Offsetting that consideration is the fact that several operated fields are older fields. High water cuts eventually become a consideration that leads to well abandonment.

The Canadian wells are more expensive. But the Cardium wells are shallow compared to North Dakota Bakken (for example). Generally, the unconventional wells have a higher decline rate.

Source: TransGlobe Energy May, 2019, Investor Presentation

One well last year initially tested more than 3,000 BOD, yet it cost probably less than $1 million. Egypt, despite the lower margins at various prices, has a lot of upside potential. The contract with the government provides for cost recovery. The company is allowed to recover all costs first before the production is split between the producer and the government. Therefore, there is a reduced risk of losses due to that cost sharing agreement.

More importantly, this company has regained the growth momentum lost in the years immediately after the oil price drop at the end of 2015. There is every reason to believe that the current oil price trading range should allow a return to production levels in excess of 20,000 BOD that existed before the Egyptian revolution and then the oil price drop.

Source: TransGlobe Energy May, 2019, Investor Presentation

The two slides above represent some of the more significant plans of capital expenditures in the current fiscal year. Note that the large discovery in the second slide will not contribute significantly to the anticipated production in the current fiscal year. The next fiscal year should have a significant production boost as a result.

In the meantime, several more exploration wells will be drilled prior to year-end. There should be at least one significant discovery in announced in the second half of the year.

What would be interesting is the effect of horizontal well technology on these fields. That technology brought back the Austin Chalk for commercial production in Texas which produced from conventional wells for decades. If and when the time comes, it would be fascinating to see what unconventional technology would do for these fields.

Several are now at the water-flooding stage. That could result in significant production for some time. The question is how to get still more oil once the water-flooding effectiveness declines. A company as small as this one generally operates the fields that the larger operators are no longer interested in. But Egypt produces far more oil from these older fields than some other countries in a similar situation. Those "discovery wells" and the amounts shown above in these older fields are seldom matched elsewhere in the world.

Future Prospects

The enterprise value of the company is very cheap when compared to first quarter annualized cash flow. Currently, the enterprise value as shown below is only twice the annualized cash flow. Note that this company sells its oil on an irregular basis. Therefore, the cash flows in lumps. Still, the company has a strong cash position. Net debt is often very low or even negative. Currently, receivables are on the high side. But that should change before the next quarter is reported.

Source: TransGlobe Energy May, 2019, Investor Presentation

The major discovery shown before should automatically increase production significantly in the next fiscal year. The stock has a semi-annual dividend that totals $.07 per share a year. As production increases, that dividend should also increase.

Balance sheet strength is a priority with the company because cash is received irregularly for production. Management has continued talks with the government to increase the number and regularity of sales so that the cash flow is a little more steady. In the meantime, significant cash flow variances between quarters will be the norm.

This company is dirt cheap. It is technically headquartered in Canada. But the reports are in United States dollars and most of the business is in Egypt. This is not a typical Canadian company. But the stock has been lumped with the rest of the Canadian industry and all the perceived challenges of the Canadian industry.

Production is growing for this company. There is one block with a major discovery announced a few years back that still has not received clearance for the company to operate. Because of the situation with this block, the company has impaired the block and discovery value in the first quarter. Discussions with the government have begun on how to properly handle the situation or return the lease to the government.

In the meantime, I would be hard to find a stock with a more asymmetric return. The downside potential here is very small because the cash flow is such a large part of the price. On the other hand, the production growth nearly ensures long-term revaluation of this security as the production success continues in the future. Even if the stock doubled in price, the cash flow would still be a very large part of the stock price.

The balance sheet strength and relatively low price make this security relatively safe for a great variety of investors despite the micro-cap category.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

I analyze oil and gas companies like TransGlobe Energy and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies -- the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

Disclosure: I am/we are long TGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.