Taking Stock After Rough Waters

Disclaimer: This is not investment advice, nor is it a recommendation to buy or sell shares in the company/companies mentioned.

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The information contained herein is accurate to the best of the author’s knowledge, but the material and interpretations contained herein should be independently verified by any party using this information as part of any research, editorial, or decision making process. Any views expressed here represent the author’s opinion only, and as such readers should do their own research and come to their own conclusions if they are using the opinions contained herein as part of any larger due diligence process. The author may have long or short positions in the companies mentioned and may be buying or selling in the market depending on which way the wind is blowing at any given moment. Opinions are subject to change without notice. Prospective resources, predictions, comparisons, financial projections, and extrapolated metrics are, by their nature, subjective and interpretation dependent. The topics covered are highly speculative and involve a high degree of uncertainty and risk. Speculative companies can and do go to zero. By using this site, you agree that the author(s) and Hydra Capital is/are not responsible for any damages incurred by the use of the presented materials. Anyone reading these blog posts should know that they are the author’s thoughts and opinions, which are not to be confused with or construed as research reports.

Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long TXP.TO, ORO.V, ORS.V, CHE.UN.TO, NTR.TO, TECK.B.TO, YGR.TO, ENB.TO, SDE.TO, ARX.TO, and ATU.V

I’ve been quiet lately, but it’s not for lack of interest in the market. Quite the opposite in fact. Largely though, I haven’t changed my tune. I still very much like Touchstone Exploration (TXP.TO, last at $0.86) for its onshore gas discovery in Trinidad and I’m seeing market interest really pick up there. In addition to recognizing the predictable nature of its cash flow from gas, the market is starting to come around to the range of possibilities for what this could be worth. My sense is that the market is a little wary of getting too bullish ahead of Chinook drilling results, but I don’t think we’re there yet. With Cascadura-1ST downhole pressure data pending and a resource estimate on Cascadura about a month later, longs should get a decent handle of what the “backstop” looks like on TXP before Chinook reaches total depth, but make no mistake, a lot rides on Chinook. If Chinook misses, the market will likely assume that Cascadura is a one-off and speculators will hit the exits en masse for a few days/weeks before the Cascadura Deep target comes into focus. If Chinook hits though, the stock could go parabolic as market sentiment swings to something resembling “these guys can’t miss”. It’s sure to be interesting and the days/weeks going into Chinook results could be a tense moment depending on where the share price is at the time. Personally, I think the story is well backstopped at current levels, but there’s no accounting for sentiment and this market isn’t exactly even-keeled in that department. Chinook is an alluring target because it is just a mile south of Cascadura, but it is in a different fault block and thus is an independent structure. In faulted areas like this, you are relying on the faults sealing, or your target reservoir being faulted against something impermeable to make a trap for the hydrocarbons… and all of this assumes that your geological/geophysical interpretation is accurate, which is tough to do in a complexly faulted area (never mind the actual drilling!). There is encouragement from an old Shell well that produced some oil from what are interpreted as the sought-after Herrera sands, down-dip of the Chinook-1 target, but in the same structure. In that sense, Chinook resembles Cascadura; Cascadura-1ST had also had an old Shell well in a down-dip location (in the same fault block) with hydrocarbon indications and that sure turned out okay so far. It’ll be interesting to see what the market does with TXP over the next few months. The speculative value in names like this can range from “zero” to “quite a lot”. Because there are no official resource estimates for Cascadura yet, there is an inherent speculation in the name already, but I don’t think the market is stretching too much yet on valuation based on my view of what’s on the table.

To the Canadian oil front… Altura Energy (ATU.V, last at $0.18). I still own it. Their netbacks on oil (70% of their production mix) at current price levels are around C$20/bbl and wells are now being brought back on stream. That won’t happen overnight, but that oil isn’t going anywhere and ATU is still funded for a well at Leduc-Woodbend and another exploration well at Entice as a result of a deal they cut last year to basically sell 1/6th of the company’s assets for C$10mm. It’s a call option on oil with one of the best management teams I’ve ever come across in a junior. I hope oil goes for a run, because these guys deserve to be rewarded for their patience and fiscal prudence. There appears to be some 40-80 million barrels of recoverable oil on the table at Leduc-Woodbend and that’s nothing to sneeze at given where it is located. You can get to any well site in the oil field and the coffee you bought at the Tim’s in Leduc will still be piping hot. This hasn’t been a great holding for me, but I haven’t seen this one in a good oil tape yet, so I’m hopeful that the ticking time bomb of oil-sector underinvestment moves prices to levels no one thought possible. I guess we’ll see if that happens. I bought some Yangarra (YGR.TO, last at $0.68) recently to get a little more Canadian E&P exposure. I like the CEO here a lot (real operator, real focus on costs, long lots of stock, bought stock recently, knows how to get deals done) and the stock is stupidly cheap relative to its NAV. YGR trades at about 30% of its most recently published PDP NAV (that’s only its wells that are drilled and on stream), but it trades at just 7% of its 1P NAV. Seven percent of 1P… hmmmmm. YGR’s 2P NAV is $17 per share. This is a stock that currently struggles to hold onto a 70c share price. I know that NAV’s can be inflated by assuming high future development capital, but the discount to its 1P NAV is the highest I think I’ve ever seen in a company unless it was going bankrupt. Given that I think the energy market is coming out of a trough, not going into one, I don’t mind owning something as beaten up as this one. The balance sheet isn’t “great” (~2x D/CF) but it’s not that bad either, and this really is a cheap option for me. The stock has seldom been cheaper and, well, I like to try to buy low and sell high. I also find myself holding a recent chunk of Spartan Delta (SDE.TO, last at $3.20), the fourth iteration of the Spartan franchise that has a self-stated goal of being a roll-up vehicle that optimizes costs and free cash flow. Sounds good to me. It’s a new story, so it’s early, but this is Bellatrix reborn without all of the debt and commercial contracts that sunk that story and it’s being led by a team that’s done well for investors in the past… a few times.

New Oroperu (ORO.V, last at $1.80) has been my favourite diamond-in-the-rough find. People ask me how I find these things. My answer: a long memory. When I first came across this story 6 or 7 years ago, I knew it wasn’t going anywhere any time fast, but I marked it in my mental calendar and watched gold in the meantime. Now, with the wind the sails of the gold sector, Barrick’s option agreement expiry date of December 31, 2020 is fast approaching and the market knows it. Even with its recent move, New Oroperu has a market capitalization of just $44 million; one of the blessings of having such a tight share structure. When I look at the Tres Cruces project relative to other opportunities out there, and I especially when I see recent deals like the Artemis deal for Blackwater, I get the sense that ORO holders are going to do just fine in 2020. This is basically a Teranga-Massawa deal in reverse (in that deal, Barrick had the deposit, but not the facilities) so I look forward to seeing it play out. The new corporate presentation on the company’s website (the first I’ve ever seen from them) is a very good run through the project and highlights why Tres Cruces is sure to get attention from a number of angles. The oxide cap has produced some very impressive intercepts at show depths with low strip ratios which really juices the economics here. Meanwhile the total resource of 2.6 million M+I ounces (plus 0.6 million ounces inferred) is open to expansion laterally and at depth. The potential for high-grade feeders at depth has already been realized in a number of past drill holes and most drilling on the deposit is limited to 300 metres or less. As a standalone story, this would still screen as one of the cheapest gold projects out there. In the windfall scenario, where Barrick simply walks away, a low-cost oxide heap leach project could likely be built for US$60-80 million, which is a pittance to the cash flow it would produce (I’m running with US$1000/oz operating margins on the oxide ounces). Right now I’m looking forward to seeing a resource estimate that breaks out the oxides separately for the first time, because that’s going to give me a very good idea of the minimum NPV of the project, or even more simply, what Tres Cruces is worth to Barrick if they run the oxides through their plant at Lagunas Norte. Barrick has reported that it has been recently drilling within the greater Lagunas Norte area, presumably looking to see if a more broad-scale project can meet its internal materiality hurdles (a higher bar for Barrick than most). It’s interesting to note that the Tres Cruces deposit even shows up in some of Barrick’s LN technical reports. This is a 1+1=3 scenario all day long and it’s been a long time coming. There are a lot of ways that this can play out and the company seems to be getting its ducks in a row before the show. My base case value here, based on 50% of the NPV10 of the 2% NSR and just US$50/oz for ORO’s 30%-carried-interest ounces, is around C$100 million… and in this gold tape that may just prove to be overly conservative. 

And then there’s tiny Orestone (ORS.V, last at $0.125). The exact opposite of a value buy. It is a pure speculation on a shoestring exploration drilling program that should start soon, after having raised the funds in May. I look at a lot of exploration targets, and this one is so simple that even I can understand it. In a nutshell, Orestone’s Resguardo project is in a copper/gold belt in Chile that has produced many monster deposits. Historically, there were high-grade (1-7% Cu + 0.5 g/t Au) copper oxides mined from a shallow mine that followed brecciated, high-energy rocks down to around 100 metres depth, at which point the mineralization ran out. A couple of holes were drilled from upslope to test under the mine workings but found that the mineralization was not connected to anything, which is always interesting, because high-grade copper in breccaited/high-energy rocks doesn’t fall from the sky. It comes from below or laterally, or maybe a bit of both. I’ve read that at least one hole drilled under the old workings did intersect manto-like copper mineralization, but nothing that enthused those who drilled it at the time, who were not looking to solve a geological puzzle. At some point around the same time, a few IP lines were run near the mine and a potential IP anomaly to the west was flagged and recommended for further follow up. Soon after, the project was then left idle for years as sector interest faded. After that, Orestone was the next to roll up its sleeves on the project. The first thing they did was run some more IP lines over the old “lead” while doing a bit of field work at surface. The IP survey revealed a high-chargability anomaly that is just west of the old mine workings, and there are copper oxides leaking out of fractures at surface in moderately-to-strongly altered rocks above the IP anomaly. It’s exactly the kind of target that needs to be drilled, especially when 1) the technical set up is so similar to that of the Candelaria discovery and 2) the project is at the intersection of two regional scale structural trends. It’s a cheap shot at something that could be huge, but the risk is also exceptionally high, so the only way to manage the risk is with bet size. When I look at the range of market caps that other companies command based on prospects not nearly as advanced as Resguardo — and remember that Resguardo can be drill tested for something in the range of CDN$300,000 starting in a few weeks’ time — at least I know I’m not overpaying for what is a “good shot” at the exploration lottery. As they say, roll them dice.

When it comes to bigger, more stable companies that pay dividends, I’ve been liking the look of the Nutrien (NTR.TO, last at $49.27) chart lately (recall that’s the relatively new combination of Potash Corp and Agrium) and am waiting for the stock to break though the C$52 level, at which point I think it would probably be heading a lot higher as part of the reflation trade. Teck Resources (TECK.B, last at $14.11), Chemtrade Logistics (CHE.UN.TO, last at $5.88), Enbrdige (ENB.TO, last at $42.13), and Arc Resources (ARX.TO, last at $5.13) are all interesting to me as well. Chemtrade has only had a 5-handle one other time over the 18-19 years that I’ve been following it. I told myself that the next time it got down there that I would buy stock, so I did. Chemtrade deals with waste streams (it has energy sector exposure) and boring industrial chemicals/precursor chemicals that are essential to daily life… products that most people never even think about and that no one else wants to get involved in. Generally speaking, I’m positively biased towards energy, but that’s not a one-quarter view, that’s more of a 1-2 year view, owing in large part to the fact that I think sector underinvestment over the last five years, combined with what has just happened to the sector, is going to come home to roost in the not-too-distant future. I’m all for the electric vehicle trade and have exposure to that sector, but there are a billion cars on the road right now, and I don’t think that there’s any way the world can make enough electric cars over the next two years to make a meaningful dent in automotive demand before we realize that we’re way behind in terms of what’s necessary to make the transition from oil to electric more orderly from a commodity price perspective. It’s nice to talk about the shift to EV’s but the move is in its infancy. Plenty of time for another oil squeeze or two…

I’ll end this note with a clip from a man who was so eloquent and tactful in his commentary many decades ago, that he playfully highlights the absurdity of discrimination both then and now. I think that the reason that the clip elicits such a gut-busting reaction from the audience and interviewer is because Ali’s short stories and quips highlight what is self-evident to anyone with even an ounce of introspection when it comes to racial discrimination.