The Wisdom of Kenny Rogers

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Disclosure: The following represents my opinions only. I am long ATH.TO, ATU.V, B.V, BTE.TO, CJ.TO, CPI.TO, DCMC.V, ERF.TO, FOM.V, GIII.V, MEG.TO, NTR.TO, NXE.TO, TAO.V, TECK.B.TO, TGL.TO, TPL.V, TRP.TO, U.TO, VONE.V, WCP.TO, and YGR.TO (Image credit to Michal Parzuchowski on Unsplash)

A little over a year ago, I invoked the great wisdom of Chumbawamba (“I get knocked down, but I get up again…”) after a disappointing 2019. I guess that you can analyze markets and stocks all you like, but sometimes you also need to listen to whatever theme song your inner DJ puts forth. Well, after some insane action in 2020 that turned out pretty well — through luck, skill, or a little of both — lately the spirit of Kenny Rogers’ The Gambler has been rattling around my head…

You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run
You never count your money
When you’re sittin’ at the table
There’ll be time enough for countin’
When the dealin’s done

While most people were whipsawed in one of the most brisk and violet market corrections in history in 2020, as long you got back up on the horse by summer time, most unwarranted market wounds have likely been healed by now — and then some. In sticking with my ox-like nature for 2021, I’ve shifted things around a little here and there, but generally I’m a broken record. Energy and materials remain front and centre in my holdings and I’m seeing good volume and price action in a lot of things. It’s been a long time since I’ve felt a market like this for these sectors. This is the kind of market that tests your ability to remain objective about valuations, and trying to remember a forgotten time when resources were cool and didn’t trade at nobody-cares-about-this-sector multiples. I think this is why Kenny Rogers keeps popping into my head. If you know what you own, why you own it, and what you think fair value is; you’re ahead of a huge percentage of the market in terms of knowing if you still want to hold it. Typically, buying stocks that trade at 50-200x earnings (that’s me knocking a lot of the tech sector) is typically not a path to long-term wealth creation, because when the sh*t hits the fan — and it always does eventually — those are often the kinds of positions that crumble under a stampede of panic selling. Call me old school, but I think that the word “value” should at least be considered in the context of any position. So to bring it back my inner DJ’s song choice, how do I know when to hold ’em and when to fold ’em?

Honestly, I don’t. You never sell it all at the top and you never buy it all at the low, well almost never, but you get my point. All I can say now is that copper stocks have had HUGE runs over the last year. If all you did was buy and hold Freeport (FCX.US, last at $38.90) during the 2020 market implosion, you’d be up ten times on your money. Same with Capstone (CS.TO, last at $5.33) and Copper Mountain (CMMC.TO, last at $3.90) here in the Canadian market. Companies that looked like questionable going concerns a year ago are now printing money, and the copper price is nearly $4.50 per pound. Oh how times have changed. Can you hear that? In my own tone, there’s a sense of high spirits and big wins when I think or talk about copper. That tells me that we are well-advanced in the copper trade. I’ve read that “copper is the new oil”… and when I start reading catch phrases like that, I know that the generalists have arrived and are buying names like those mentioned above for the first time.

And why wouldn’t they? Copper is going to be critical for the coming Green Revolution, right? Absolutely. Copper could be $6 a pound tomorrow and it wouldn’t change copper supplies next year very much (mine supply takes time to respond), but boy would it ever pile up the cash on the balance sheets of copper producers. Heck, $4.50/pound is so far in the money for even the most marginal copper producer that very little doesn’t work at these price levels. Given the newfound nature of the copper miner’s windfalls, I haven’t seen much M&A yet in the mining space yet, but with the equity valuations of the copper producers creeping higher and interest levels still increasing, I’m starting to become more interested in pre-development and exploration stories. Given the outsized wins I’ve had on names like CS and CMMC, I’ve scaled those big winners back… they used to be dirt cheap, now they kind of look like fair value to me; but that’s not to say that the market can’t overshoot fair value to the upside (but that’s a different bet than them buying/holding cheap when not many cared). With some of that cash, I’ve added a little to smaller names (like Foran Mining, FOM.V, last at $1.36 and Dore Copper, last at $1.23) that I think are well-positioned and have taken the rest of the money and moved it up-cap into boring things like Teck (TECK.B, last at $26.50), Nutrien (last at $70.50), and TC Energy (TRP.TO, last at $61.30) while I survey the table a little more.

Oil is a slightly different story for me. While some of the oil stocks have had big moves off their lows, it still feels very early on the energy trade to me. Yesterday was the first day that I saw what looked like “tidal” money flows coming into Canadian energy stocks. This comes on the back of continual investment bank upgrades with respect to their outlooks for the energy sector. Anecdotally, it seems that most money managers and retail investors alike have little or no “traditional” energy exposure, which says something about what inning I think I’m in on the trade. I think that energy is lagging around 9 months behind copper and if that’s the case, it could be quite a year ahead. I’ve increased my energy exposure recently and am a broken record when it comes to the names I like. AAV, ARX, ATH, ATU, BTE, CJ, CPI, ERF, GIII, MEG, TAO, TGL, TPL, TOU, TVE, WCP, and YGR make up most of my energy exposure. That’s a lot of ground to cover, but I can quickly frame all of them, so here goes:

Advantage Oil and Gas (AAV.TO, last at $3.31)

A low-cost, best-in-class Montney gas producer in Alberta. Relatively gassy with leverage to AECO and a disciplined hedging program. Trades at an average multiple relative to peers, but recent news has guys in the office thinking that there’s a big embedded call option within Advantage. Advantage’s new, wholly-owned subsidiary called Entropy, has developed a carbon capture technology that generates a positive return at a $50/tonne carbon price, a significant industry breakthrough. Given the importance of carbon sequestration initiatives within government policies at home and abroad, the potential applications/implication for Entopy’s modular carbon capture solution are far reaching. Advantage plans to release updates on Entropy’s progress periodically in the future, independent from the company’s usual corporate updates.

Arc Resources (ARX.TO, last at $7.87)

Having closed its merger with Seven Generations Energy, ARX now trades at a discount multiple relative to peers despite having significant scale, free cash flow potential, condensate exposure, and leverage to energy prices. Value players tend to like ARX and will likely find little fault with it here.

Athabasca Oil (ATH.TO, last at $0.72)

Ninepoint’s increasingly-in-demand Eric Nuttall set this stock on fire on Friday by making it one of his top picks… and he can tell it better than I can, so here’s a link to the show (ATH is discussed near the end). In a nutshell, ATH is a “super-call” on oil… a.k.a, the leveraged bet.

Altura Energy (ATU.V, last at $0.18)

My penny hopeful. With a circa 400 million barrel OOIP resource just outside of Leduc, Alberta, ATU is like a snake that ate a deer (i.e., small company, big asset, loads of running room, but it takes time to get moving). I’m not sure what gets ATU lit this cycle, but this is a bet on management and oil prices for me. ATU’s well economics at Leduc Woodbend look pretty attractive at current prices.

Baytex Energy (BTE.TO, last at $1.56)

I didn’t know that BTE had entered the Clearwater play, so that’s a nice recent bonus. BTE screens as having one of the highest free cash flow yields on comp sheets at current prices. I own a little of this one as part of a shotgun strategy. Nuttall covers the relevant bases as well as anyone in this video from his recent BNN appearance (I keep posting the full video link because anyone serious about energy should be listening to Nuttall and his ever-sharp focus right about now).

Cardinal Energy (CJ.TO, last at $2.95)

CJ is juuuuust getting to its end-of-the-world December 31, 2020 1P net asset value. If you ran the reserve report again with the current strip, I think you’d find that CJ trades at at little over half of its NAV (just look at its YE 2019 reserves values if you don’t believe me). Nuttall likes CJ as well, and we both seem to like the idea of riding shotgun with Murray Edwards, so let the band play on and here’s hoping oil keeps going higher. CJ still screens as having one of the best free cash flow yields out there and this could be a tuck-in acquisition for someone or it could be on the road to Dividendtown. I’m okay with either.

Condor Petroleum (CPI.TO, last at $0.46)

With a focus on Uzbekistan, Kazakhstan, and Turkey, Condor doesn’t exactly attract a lot of attention, but I mention this one only because I remember the Hurricane Hydrocarbons story back in the day and I think the Uzbek deal that CPI is working on could be Hurricane-like. If you know what Hurricane Hydrocarbons was, that might get you thinking about getting up to speed on CPI. If not, don’t worry, most of the market is in the same boat, but at least you’ll have heard of it. I have no idea on timelines here, but I’m thinking sometime this year for an Uzbek deal if it happens (it would be a field revitalization project, and would be a critical piece of business for the nation, so this isn’t small potatoes they are going after).

Enerplus (ERF.TO, last at $6.80)

North Dakota Bakken producer. Gobs of free cash flow at current prices. Historically regarded as a premier company with a premier multiple, but right now, it’s cheap, with one of the highest free cash flow yields in the sector. Again, Nuttall lays it out perfectly in his BNN appearance.

Gen III Oil (GIII.V, last at $1.80)

After following this for years and never caring, I started watching as the story started building momentum several months ago. This is an oil recycling story, but Gen III’s secret sauce gives them a high Group III oil yield, which is a high value product. Yesterday, GIII inked an offtake agreement for its planned 5,600 bopd facility with a “supermajor” who shall remain nameless for now, but presumably not forever. This obviously has ESG appeal and comes with a potential significant carbon offset credit call option. I own a little because it’s neat story, but this is a pure speculation for me and I only mention it because it’s nice to see new technologies focused around recycling used oil. I can’t speak intelligently to valuation on this one yet, but I’ve got a toe in the water and will see how it goes.

MEG Energy (MEG.TO, last at $7.29)

With billions in tax pools and some of the best leverage to WCS pricing that I can think of, MEG is starting to look pretty juicy as a takeout target. There are plenty of operating oil and gas companies that could use MEG’s tax pools, take on MEG’s debt, and mint sweet free cash flow at anything resembling current oil prices, never mind $5-10-15-20/barrel higher. A leveraged bet with a target on its back. That’s the view on MEG from my perch.

Tag Oil (TAO.V, last at $0.29)

Nothing new here. Ramadan ends on May 12th, so I expect that if something’s going to happen, it will be after that. Backed by some 19-20 cents per share in cash and with a cast of characters that I like very much, I am very content to wait and see what TAO blossoms into. I think their timing will be perfect.

Transglobe Energy (TGL.TO, last at C$1.95)

I’ve pounded the table plenty on this name, so I won’t do it again, but feel free to go back and read my previous posts on this one. The next big catalyst for the stock should be ratification of the new PSC terms disclosed in December of 2020 (that would double netbacks and bring 200-300% reserves upside into play, retroactive to February 2020). The timing of Ramadan is a factor here also, so ratification in late May/June would seem to be a reasonable assumption (Ramadan runs until May 12th this year). TGL is still dirt, dirt, cheap in my books (I have it trading at less than 1.5x EV/CF under the new PSC terms at $60 Brent) and will generate a lot of free cash flow at current prices. It screens among the cheapest energy stocks on any comp table, and the one you’re most likely to find it on is that of Charlie Sharp out of the Canaccord UK office. Charlie has a 245p target on TGL/TGA, which equates to CDN$3.95 or US$3.20.

Tethys Petroleum (TPL.TO, last at $0.67)

The old international energy analyst in me just can’t forget about TPL. Probably one of the weirdest international energy companies on the Canadian market, TPL has a storied past of management that couldn’t seem to get the job done (that’s me being kind) despite modest drilling success over the years. I checked in on TPL again a while back when their new Klymene oil discovery in Kazakhstan hit the newswires. TPL is effectively controlled by Pope Asset Management and I’m cheering for them on this one, but it’s a roll of the dice here. This is what Tethys had to say about a recent reserve report prepared by McDaniel on Klymene: “Tethys has received a resource report and reserves assessment from McDaniel on the Klymene field. This report was prepared in compliance with National Instrument 51-101 — Standards of Disclosure for Oil and Gas Activities, and the Canadian oil and gas evaluation handbook. The summary of mean reserves is estimated to be approximately 94.8 million barrels of crude oil, with a P90 low estimate of approximately 35.8 million barrels and a P10 high estimate of approximately 174 million barrels.” Clearly, TPL has some oil on its hands, but getting it out of the ground (and getting paid a fair price for it) is another matter altogether in Kazakhstan. TPL plans to drill a few more wells into Klymene, with the cash flow from early production tests “hopefully” funding the costs of the wells themselves. This is the definition of bootstrapping in international oil and gas, but given the market cap, and the fact that this seems like a classic target for any player in the region, I own a tiny, tiny, bit and mention it only to point out what strange things lurk in the dark corners of the market if you look. Liquidity is terrible and TPL is hanging on by its fingernails, but the Klymene tests to date have been impressive enough to keep me in the peanut gallery.

Tourmaline Oil (TOU.TO, last at $27.60)

TOU consistently comes up as one of the the “go to” names for gas exposure in Canada, full stop. TOU also has good leverage to the California natural gas market, which is looking like it could be in for higher prices this year as drought in the Western U.S. reduces output from hydroelectric sources this summer.

Tamarack Valley (TVE.TO, last at $2.71)

TVE has been a busy acquirer as of late and now boasts positions in two of the most economic oil plays in Canada… those being the Clearwater and Charlie Lake. Given the level of attention that it’s getting in the market, I’ve got this in my oil basket, but I am wary of TVE choosing to grow production instead of returning capital (aka free cash flow) to shareholders through buybacks and/or dividends. If oil prices keep going, I think that TVE (along with many of its peers) would likely be able to do both.

Whitecap Resources (WCP.TO, last at $5.41)

Whitecap trades at a bit of a premium to its group average, but I think that’s warranted given its standout presence in the carbon sequestration business. Whitecap actually stores more carbon dioxide than it emits through all of its operations via its world-class carbon sequestration project (CO2 flood) in the Weyburn oilfield in Saskatchewan. WCP has been lagging some of its peers a bit lately, but I think this story will appeal to managers that may want to cover their ESG butts by owning a “net carbon negative” oil producer.

Yangarra Resources (YGR.TO, last at $1.20)

I still like this very much as a small cap Cardium oil play that will generate its market cap in free cash flow in a couple of years at current oil prices. YGR’s stated goal is to return free cash flow to shareholders through special dividends, perhaps starting around Q2 of next year, after it pays down some debt in 2020. Insider ownership and shareholder alignment is high with this one and YGR will see its cost pressures somewhat insulated by all of the equipment it owns. The company is among the cheapest out there on the broker comp sheets.

Man, that’s a lot of reading already, so I’m not going to ramble on too much more. Overall, I’m channeling my inner ox (head down, plowing ahead) when it comes to energy and materials with a dash of special situations involving select exploration stories and deposits. On the zero-carbon energy front, uranium looks set to rip higher (read that link) and I think that Nexgen (NXE.TO, last at $5.05) and Uranium Participation Corp (U.TO, last at $5.30) are two relatively low-stress ways to play that sector. Vanadium One Iron Corp (VONE.V, last at $0.25) has my attention as a junior resource player in the red-hot iron ore space… I think that VONE will be talking about close to a billion tonnes of high-quality iron ore in a good area in Quebec once it updates its Mont Sorcier resource estimate. Will anyone care? I’m not sure, but the market cap is low enough for me to take a punt given how hot iron ore is right now and the fact that Largo Resources alumni Mark Brennan is involved. Generally speaking though, I’m trying not to get distracted by too many shiny trinkets as I make my way through this market, but a few fliers always seem make their way into the basket. The smallest of the fliers is tiny little BCM Metals (B.V, last at $0.20), which shooting for the moon in Utah at its “blind” (covered by gravel) Thompson Knolls porphyry target (Quintin Hennigh does a great job of telling the story in this video). It’s a real treasure hunt with a suitable amount of intrigue, but it is exceptionally high risk. I want to track targets like this though (just in case they hit), especially given the scale of the target, the share structure, and the market cap.

Given that the world has just barely started taking the covid cuffs off, I’m optimistic about what the coming months and years could bring, so I’m mostly sitting on my hands, with some adjusting of positions here and there based on valuation. Being right and sitting tight is sometimes hard to do because it takes conviction, but if what’s happened to copper is any indication of what’s to come for energy, things could get really interesting. I say that because some of the copper stocks appear to be trading a lot closer to what might be considered “fair value”, but most of the oils are still really, really cheap. I don’t think anyone thought that lumber would smash through $1500 per thousand board feet a year ago and right now I’d ask how many are calling for $100 oil a year from now? Now that’s something to think about as the words of Kenny Rogers rattle around in my head…

Happy hunting.