Summary
- Production Costs of $26 per barrel are lower than even Middle East producers.
- TAOIF is trading at less than 2X Cash Flow.
- Tag Oil is profitable and debt free.
- Canadian listed junior E&P with operations in stable New Zealand.
Tag Oil (OTCQX:TAOIF) just reported (see their 4/16/2015 operational update) production costs of only $26 per barrel. Their production costs are lower than most competitors including OPEC's onshore Middle East production as shown by this chart. The recent decline in oil prices has amply demonstrated the importance of being a low cost producer.
Why does Tag Oil have such low production costs? They are drilling shallow conventional wells at their Cheal field. These wells cost just a few million dollars each to drill and don't require expensive fracking. Tag Oil already has extensive infrastructure available and royalties are very low.
At a recent price of $1.40 TAOIF has a market capitalization of $87 million. However the enterprise value is just $62 million after netting out the cash on their debt free balance sheet. As per their 4/16/2015 operational update, net production is now running at 1,970 BOE/d (about 77% oil). Production increased 8% sequentially for fiscal Q3 ended 12/31/2014. Further production increases are expected as the company continues to focus on high return shallow drilling.
Based on their recent production growth rate, Tag Oil should conservatively end calendar 2015 with production of at least 2,250 BOE/d. December 2015 Brent futures are now trading near $70 per barrel. December 2015 operating netbacks should therefore be about $39 per BOE including some lower value natural gas production. That puts the December 2015 annual operating cash flow run rate at:
2,250 BOE /d * 365 days * $39 / BOE = $32 million
Based on the above, Tag Oil is now trading at Enterprise Value / December 2015 Cash Flow Run Rate of $62 million / $32 million = 1.9X This is an extremely low valuation for such a high quality growth company. In fact it would be an exceptionally cheap valuation even for a company with declining revenues in a mature sector. See my recent Seeking Alpha blog article for more perspective on how remarkably cheap this valuation is. Comparable E&P companies sell at far higher multiples even though they operate in countries where infrastructure is not readily available and geopolitical risks are much higher. Forbes ranked New Zealand #3 on their 2014 list of "Best Countries for Business". The U.S. was in 18th place.
Tag Oil is also undervalued by other metrics such as reserve valuation and midstream assets. 2P reserves were valued at over $200 million for the fiscal year ending on 3/31/2014. Property plant and equipment was $113 million as of 12/31/2014. Bear in mind that the total enterprise value of TAOIF is only $62 million.
Tag Oil is a profitable growth company with a strong balance sheet that is trading at a very low cash flow multiple and a large discount to asset value. Therefore, its not surprising to see some insider buying. Alex Guidi (founder and CEO) and other insiders have made several open market buys over the past year. The company itself repurchased and cancelled over 1.7 million TAOIF shares for the 9 months ended 12/31/2014. Recent Canadian insider filings (TAOIF trades in Canada as TAO.TO) show that open market share repurchases have continued on a regular basis.
Oil now accounts for over ¾ of Tag Oil's production. Natural gas used to account for a larger share of production and the infrastructure is readily available for increased natural gas production if warranted by market conditions. TAOIF has a controlling interest in a small electrical producer (Coronado Resources) which provides a captive market for a portion of it's natural gas production.
How come such a high quality stock is trading so cheaply? Over the past couple of years Tag Oil took some "home run" shots on deeper drilling that could have dramatically increased production and transformed the company. Unfortunately their Waitangi Valley well on the East Coast was an expensive strike out. The company is now looking for joint venture partners to help fund any further deeper drilling. If they can't find joint venture partners they appear likely to abandon some leases.
Recent production increases demonstrate that their shallow drilling strategy is already starting to pay off. The days of capital spending far exceeding cash flow are over. Investor confidence should improve as this "back to basics" strategy is maintained.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Additional disclosure: TAOIF is covered in the Panick Value Research Report, mrpanick@yahoo.com for the 2 week free trial.