Spyglass Resources: Looking Under The Hood

Just a few months ago around Christmas time, a 3-way merger was announced between Pace, Charger and Avenex Energy. Spyglass was the resulting entity, a new dividend paying corporation with a balanced commodity mix.

It was a messy transaction on all fronts; the vote was postponed twice before the deal finally closed. Obviously, not everyone was happy especially with Pace and Avenex.

Nova Bancorp Ltd, a Pace shareholder, was very aggressive fighting the deal going so far as issuing press releases. One would think they held a substantial percentage of the company seeing their determination. But for a position representing less than 0.2% of the total amount of shares, their fight only cost Spyglass unnecessary expenses and delayed the merger.

On the Avenex front, selling Elbow River at 4.7x cash flow multiple was not well taken by shareholders. This was the company’s cash cow division funding most of the dividend. It seemed like the Avenex team just gave up…

Some investors dreamed of unlocking value through a corporate sale process. That’s particularly true for Pace given its net asset value was easily above $5.00 ($5.70/share for PDP and $6.80 on TP basis.)

The only problem is, we are in a buyer’s market with around 300k boepd for sale, this is simply pie in the sky thinking. Combining the 3 companies into a dividend paying entity , in my opinion, makes more sense in the long run given the O&G market we are currently going through.

spyglass resources

click to enlarge – consolidated asset based

The new Spyglass Resources SGL.TO 2.04 [0.00] has its advantages and disadvantages.

On the positive side:

  • A decline rate of 20% perfectly fits the dividend model
  • The payout ratio is sustainable using the current price deck (<100%)
  • A huge land package with more than 1,000 locations to drill (multi-year drilling inventory)
  • Balanced commodity mix provides exposure to any upside in NG

On the negative side:

  • Debt is simply too high, almost 3.0x in 2013
  • The CEO comes from Charger Energy whose stock lost more than 80% of its value in 2012. This means market confidence in this management team will have to start from 0.

For those who bought Avenex Energy above $5 and are still holding, my condolences because you will neither be seeing this price in 2013 nor in 2014. The share price upside is capped at a maximum of $4.5/share for a yield of 6% from the current level of ~11% at $2.50 per share.

The 6% yield is based on Whitecap Resources WCP.TO 11.91 [-0.03], a well-run company with a respected management team. In order for Spyglass to get there, it will take several quarters of flawless execution and much lower debt levels. It can happen, just don’t hold your breath as time only will tell.

Mid-range, we may see $3.00 following a few quarters of successful execution if the yield compresses to 9%. You have to keep in mind, that the market will become more comfortable with the company as it builds history. The positive aspects enumerated above will certainly attract investors over time.

Management will be looking to reduce debt through non-core asset dispositions. These assets would not fit a dividend model due to high decline rates. The Slave Point play at Randell is one candidate for example. Spyglass might potentially be able to fetch a few million dollars from small asset sales, but the market will only price these in once they happen.

What matters the most in 2013 is the total payout ratio. The company has not initiated a  DRIP program yet. This year’s scenario calls for the following:

  • Average annual production of 16,000 boed (51% oil)
  • Edmonton light at ~$89 = realized price of $74.23
  • Natural Gas at $3.39/mcf AECO
  • 2013 capex of $75 million (mid-range)

It’s important to note the realized price based on Edmonton Light. The company’s oil production is a blend of heavy, medium, light sweet and light sour oil resulting in the cocktail price you see above.

The price for natural gas makes sense given storage is at or heading below the 5 year level. Spyglass has decent hedges in place with 34% of its estimated crude oil production hedged at an average floor price of C$94.84/bbl and approximately 41% of its estimated natural gas production hedged at an average floor price of $3.02/gj.

My total payout ratio estimate is below 100% right where the company guided (95%-100%)

SGL 2013 payout ratio

Even though oil price differentials have narrowed lately, I do not believe the problem is solved. This is an issue worth keeping an eye on as it would have an impact on the share price if we re-experience differentials volatility in the coming quarters. This is a risk you need to remember.

Finally, this is a show me stock. Capital gains upside in the near term is limited, it will likely materialize in 2014 if natural gas prices keep improving in tandem with a dropping Debt to CF multiple.  With time more investors will be getting comfortable with the company given the sustainability of the dividend. This is a stock with long term potential that could see it unfold in 2014.

What do you think of Spyglass?

18 comments to Spyglass Resources: Looking Under The Hood

  • W.C.

    Well, RPL went from the growth model to divy payer and their high debt issue has caused the SP to tank. I would think Spyglass is essentially in the same boat and unless their high debt can be brought under control I see a similar thing happening.

    • Mich

      WC, We might see a similar scenario with SGL, no doubt about that. Time will tell really, I sure hope not as SGL is an intermediate producer with a larger production base. Things can only improve from here if they execute properly.

    • Mich

      One last thing, if NG prices surprise to the upside this year, the balanced production mix will come in handy for SGL.

  • [...] Beating The Index took a look at Spyglass Resources. [...]

  • Carnival of Financial Camaraderie - April 13 2013 - Freeat33

    [...] @ BeatingTheIndex writes Spyglass Resources: Looking Under The Hood – Spyglass is a new dividend paying corporation with a sustainable dividend and a balanced [...]

  • Alan Hume

    This is a pretty good analysis. SGL has 3 factors that can affect its stock price positively:
    1. Resurgent NG prices. (they can hardly be worse than 2012)
    2. A successful CAPEX program. It is key to show that they can get excellent results drilling their oil prospects.
    3. A more positive macro environment in general for the valuation of Energy stocks.

    • Mich

      Thanks Alan,

      Pretty much sums it up! execution + macro will be the main drivers behind yield compression. Let’s hope sentiment towards this sector changes soon.

  • [...] knows the Canadian energy markets like Mich at Beating the Index does, or at least no CoW submitter knows them like he does. This week he analyzes Spyglass: a [...]

  • hivoltage

    Spyglass states in their 2013 guidance they will exit 2013 @ 18,000 boepd .
    With a 20% corporate decline rate and ~17,500 boepd of production in Q1/12 Spyglass would need a capital programme that would add 4,000 boepd(3,500 boepd to replace corp.decline + 500 boepd to get to 18,000 boped)
    They have said they will drill 18 net wells this year mostly at Halkirk Viking and S.Alberta Glauconitic formations . 1 year average production from wells in both these areas is around 45 boepd(Pennwest 2013 Investor’s Day Presentation). 18 wells times 45 boepd = 810 boepd . This is FAR SHORT of the required 4,000 boepd needed for them to make guidance .

    • Mich

      hivoltage,

      Their guidance is for 16,000 boed in average production for 2013. The 18,000 figure is their exit guidance so my guess is if they’re going to hit this figure it can only be based on flush production. We also don’t know how much their low cost workover program will contribute towards this figure. Their $60M capex is for drilling 18 net wells + a number of workovers.

      Cheers,

  • hivoltage

    SGL has spudded 2 wells since merger in their focus areas . That leaves 16 more wells to be drilled by YE2013 . If they wait until say November/Decemeber of this year and drill the rest of their wells(16) their production will have declined to around 14,500 boepd(assuming 20% decline rate for ~3/4 of a year). That means , with a generous IP30 rate of 120 boepd , these 16 wells will have flush production additions by year end of around 1,900 boepd . Throw in ~100 boepd from workovers and recompletions and add to the 14,500 boepd their production will have decline to by November 2013 and that’s only 16,500 boepd assuming flawless execution . In that case they still miss guidance and are set up for BIG flush prodcution declines by Q2/14 .
    As a comparison to SGL’s 2013 capex effort, Longview(LNV) will drill 19.9 net wells(mostly in highly productive SE Sask) and looks to add 1,480 boepd in production additions to cover 19% annual corporate decline rate(~1,200 boepd). This is a plausible drilling campaign .

  • hivoltage

    PS
    16 wells in 2 months is 2 wells per week-highly unlikely

  • hivoltage

    Re-reading latest SGL news release they say they have 1 rig working in S. Alberta , 1 rig ready to go when conditions improve at Halkirk and 1 rig to commence drilling sometime in Q/3 at Noel .
    They’ve already spudded 2 wells in S. Alberta and they should be able to drill in Halkirk by now . The one rig they plan to use at Noel/Cadomin , i think , is for drilling to forestall land expiries in this area .
    Also ,production/cashflow is likely to fall even more when they sell assets to pay down their huge +$300 million debt .

    • Mich

      hivoltage,

      Best followup with the company to hear it from the horse’s mouth. They would probably share their financial/production model for 2013 in detail. Your theory is interesting but in the end they know their program better than you and me combined. Give them a chance to explain themselves, they’ve answered me every time I contacted them.

      Cheers,

  • hivoltage

    I don’t trust management at SGL . Look at what happened at AVF , management surely didn’t have shareholder interest in mind and now Gary Dundas sits on BOD at SGL . SGL has lied about O&G prices being one of the reason they cut the dividend from $0.03/month to $0.025/month when in fact price of NG went up around 25% and crude oil prices were up 10% from Dec.2012 , when they announced merger . to the end of March 2013 when this “deal” was finally voted through .
    I have corresponded with some of the memebers of the companies that make up this company in the past and didn’t receive a response when it came to my questions on the details of this “merger” . I trust them about as much as Poseidon(PSN) when it comes to being fully transperant and honest .

    • Mich

      hivoltage,

      I have no interests with the company so I’m not here to defend them. I can only suggest you call them, they have always returned my calls and answered my questions so far. Call them and put them on the spot, I’m sure you will be able to validate your theory.

      Cheers,

  • hivoltage

    As far as cashflow for SGL in Q2/13 ?, well let’s just do a little simple math .
    First we have to figure their production . Q1/13 pro-forma averaged 17,340 boepd . Stated base decline rate is 20% so knock off 5% of 17,340 boepd = ~16,500 boepd but with no wells coming on line and Spring Break-up coupled with wet conditions in some of their key areas and I’m thinking production averaged 16,000 for Q2/13(generous-assumes not surprises)
    Second , what is their CASH netback ? If Q2/13 average price for liquids is $75/bbl(remember it’s not all light oil) and NG averaged $3.39/mcf they have a realized sale price of ~$48/boe . Next subtract $10/boe for royalties , $20/boe for operating expenses(remember Spring-Break-up) and you get an OPERATING netback of ~$18.50/boe Then subtract $2.75/boe in interest charges(5% annual of $300 million) and my guess for G&A of $5/boe(remember “painful” merger process) and I get ~$10.75/boe
    for CASH netback .
    So 16,000 boepd x $10.75/boe x 90(days in Q2/13) =$15.5 million
    in cashflow for Q2/13 . Annualized that’s $62 million , FAR SHORT of the $102-106 million needed to sustain dividend + capex let alone repay any debt .
    VERDICT : Spyglass is unsustainable !

  • JC

    hivoltage,
    Thanks for all the math works. Do you see similar problem with Parallel Energy? From what I am seeing, production wise, they seem to be able to deliver what they promise. However, the weak NGL price is killing them.

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