Tamarack Valley Energy (OTCPK:TNEYF) (TVE:TSX) is another company jumping into the Clearwater game behind others like Baytex Energy (OTCPK: BTEGF) and exploration upstream (OTCPK: CDDRF). Management recently announced another acquisition of Clearwater. As more companies get started, this location appears to be a major new source of cheap heavy oil. But it may also put some of these players in play as acquisition candidates, as they hold very desirable and so far profitable acreage. So, as attention grows in this area, there will likely be more consolidations and acquisitions by larger players who are more conservative.
Tamarack Valley (the company) has been around for a while. But the current form is quite new. The company embarked on a series of acquisitions to take advantage of the incumbent buyer’s market to become much larger than it was recently. As a result, the company is much larger than it was and is significantly different from the company in past history. This makes past comparisons difficult for a market that wants to take the number and run.
(Canadian dollars unless otherwise specified)
Due to these acquisitions and the more favorable commodity price environment, cash flow is poised for a significant jump in the first half of the fiscal year. This would lead at least a few to forecast cash flow from operating activities of around C$200 million per quarter in the next fiscal year.
Management also expects a fairly low free funds flow breakeven point. There is always the risk that management may not be able to manage the newly merged company as planned. However, market value and enterprise value seem to take this possibility into account. This would leave considerable upside potential for the stock price as the enterprise value to cash flow from operating activities ratio appears to be below 2.
Often, the logistical challenges of a roll-up strategy are so much easier for small businesses than for larger ones. Acquisitions here are quite small, and company management seems to have the experience to make this strategy work. Therefore, despite the risks of rapid growth and numerous acquisitions, the strategy employed here seems viable and less risky than one might otherwise think.
The low break-even points shown above, combined with the low leverage, help to minimize the risk of potential assimilation issues in the future. Companies with little debt often have more time if they need more time, because debt requirements are lower. It also puts this management well ahead of those willing to consider taking the balance sheet to risky levels assuming they can pay off their debt quickly (often over several years).
If this business finds itself caught in an industry downturn, the low level of debt will allow the business to delay plans and goals while using any cash flow to hang on until the start of the next reprise. Downturns usually always wipe out the heavily indebted crowd, as debt must be repaid regardless of industry conditions. Often these terms are less than favorable to repaying the debt just when the lenders want their money back.
Management launched a monthly dividend to return a modest amount of cash flow to shareholders. Management also believes that the stock price is low enough to initiate a share buyback program. The initiated dividend is modest enough to sustain through the next industry downturn without borrowing as long as oil prices stay within the $30 WTI range. This differentiates this dividend strategy from others who will not hesitate to reduce the payout during any significant cyclical downturn.
I am often asked questions about the safety of investing in small businesses. Now, small company stocks can be volatile due to fewer shares outstanding. But, for investors who like to buy and hold in this industry (volatility and all), you want your long-term holdings invested in some of the lower breakeven pools in North America. When this is combined with the conservative debt strategy, the risk here is actually lower than it would be for some large companies trading.
Additionally, the current period appears to be a good time to invest as the latest coronavirus issues have raised concerns. The difference now is the possibility of receiving a vaccine. This will most likely prevent countries and the world at large from resorting to more extreme measures. So while the coronavirus is likely to make owning stocks of anything very bumpy, the long-term outlook seems to be that the current rally will continue.
The inflation outlook also worried investors. But inflation concerns generally benefit resource stocks. Moreover, anyone who worried about inflation should have worried about the growing deficits of the past four years. Most likely, the current recovery has caused inefficiencies that will take a few months to resolve. Any subsequent structural inflation can be easily brought under control by raising interest rates by the Federal Reserve and its open market operations as long as the deficit begins to decline again.
Investors should realize that most things Congress or the President can do take about 2 years to have an effect (inflationary or otherwise). Therefore, anyone expecting a quick recovery from the current situation may be in for a nasty surprise. However, this should make the current fearful situation a good time to buy out of favor stocks at decent prices.
The two most profitable locations will demonstrate to investors a similar ROI benchmark. The money used to drill the well comes back to the company in less than a year (much less at today’s prices). This allows the company to drill multiple wells with the same capital to quickly increase cash flow at a time when industry prices are favourable. More profitable locations also tend to generate cash flow during periods of low industry prices. This will provide this business with a source of cash flow during downturns in the industry.
This is why return on investment is so important. I follow a lot of companies with a payback period of 1 year (which is good) to 2 years (marginal). A company like this with the leases it has will have a major competitive gap as long as those leases have locations to drill. The business can grow much faster than competitors in less favorable locations. In this case, the relevant competition is most of North America. Moreover, this company has a great chance of surviving an OPEC price war if it happens in the future in very good shape. So a low investment budget can go a long way with such quick payback periods.
The low payback period also tends to demonstrate a low break-even point for this acreage. The business can grow in a wide variety of industry scenarios while competitors have to wait for better prices.
This is the kind of company that often receives takeover offers. Buyers want a well-run business at a bargain with little or no hassle. This company checks a lot of boxes on any buyer’s list. Therefore, down the road, no one should be surprised if this company is acquired.
Mr. Brian Schmidt, CEO and President, is one of the founders of the company. Mr. John Rooney is Chairman of the Board. The chairman not only has experience in the oil and gas sector, but he was also involved in the establishment of other oil and gas companies before becoming involved with this company. These two men are probably essential to the success of the company. The loss of either would be a material loss with possible investment effects in the future.