Description
Description:
Arcan Resources Ltd. (TSX venture exchange, ticker: ARN) is a Calgary, AB-based junior oil and natural gas producer. Arcan has a portfolio of light oil and natural gas assets located in the Deer Mountain, McLeod, and Hamburg areas of Alberta. (All figures in this write-up are in $ Cdn.)
Thesis:
We believe several factors have conspired to deflect investor interest from Canadian oil and gas companies, and thus left Arcan’s shares mispriced at 3.5x 2008E EBITDA:
1) On October 25, 2007, the Alberta Government released the New Royalty Framework for Alberta (NRF) – although there are several outstanding uncertainties regarding the NRF, the end result will be (to varying degrees) increased royalties charged to producers on sales of oil and gas. The NRF is set to be instituted on January 1, 2009.
2) Over the last few years, there has been a general deterioration in the economics for Albertan oil and gas producers, as the price of natural gas has moderated and the cost of land, drilling rigs, labor, etc. has increased.
3) To a lesser degree, it appears unlikely that Arcan will meet its 2007 exit target of 2,350 BOE per day. While we will address the above issues below, we feel that this concern is unfounded, as the expected production “miss” will come as a few projects are merely delayed -- we expect them to come on-stream in early 2008. Furthermore this issue is appears fully discounted by the current valuation.
Regarding the NRF, Arcan mgmt expects to have a 7% negative impact on reserve value (P+P) and an 11% negative impact on 2009 operating cash flow – ARN shares are down 48% from their peak in 2007.
Also important to note is that Arcan generates 75% of its revenue from light oil sales, and thus has enjoyed superior economics to most natural gas producers. The company’s reserve life index (RLI) is expected to be around 7 years on a proven basis, which is also superior to most of its peers. Netbacks (at the corporate level, so net of G&A) are expected to be in the $28 range, and mgmt continues to target a recycle ratio of at least 2x (defined as operating netback divided by FD&A costs). If these economic metrics are met, it is unlikely that ARN shares remain at the current valuation.
Valuation:
| Shares Outstanding (in 000s) |
36,481 |
| Price |
|
|
$2.50 |
|
Equity Value |
|
91,202 |
| 2007E Net Debt |
|
15,000 |
|
Enterprise Value |
|
106,202 |
| 2008E EBITDA |
|
30,222 |
| EV / EBITDA |
|
3.5 x |
| EV / 2008E boe/day |
|
$35,401 |
Financials:
|
|
|
|
12 Months |
6 Months |
|
9 Months |
|
Calendar Year |
| Production |
|
Jun '06 |
Dec '06 |
|
Sep '06 |
Sep '07 |
|
2007E |
2008E |
| Oil and NGL (bbls/day) |
|
127 |
373 |
|
207 |
800 |
|
1,000 |
2,100 |
| Natural Gas (mcf/day) |
|
1,209 |
1,377 |
|
1,868 |
2,384 |
|
2,400 |
5,400 |
|
Total (boe/day) -- 6:1 |
|
329 |
603 |
|
518 |
1,197 |
|
1,400 |
3,000 |
| Average Realized Price ($ Cdn) |
|
|
|
|
|
|
|
|
| Oil and NGL (bbls/day) |
|
$68.09 |
$66.00 |
|
$72.13 |
$70.15 |
|
$70.00 |
$70.00 |
| Natural Gas (mcf/day) |
|
8.02 |
6.99 |
|
7.26 |
7.61 |
|
7.00 |
7.00 |
| Revenue |
|
|
|
|
|
|
|
|
|
| Oil and NGL |
|
$3,160 |
$4,533 |
|
$4,080 |
$15,313 |
|
$25,550 |
$53,655 |
| Natural Gas |
|
3,538 |
1,771 |
|
3,699 |
4,953 |
|
6,132 |
13,797 |
|
Total (boe/day) -- 6:1 |
|
6,699 |
6,304 |
|
7,779 |
20,266 |
|
31,682 |
67,452 |
| Expenses |
|
|
|
|
|
|
|
|
|
| Royalties |
|
1,753 |
1,437 |
|
1,881 |
4,861 |
|
7,665 |
16,425 |
|
Per boe |
|
$14.61 |
$12.96 |
|
$13.29 |
$14.88 |
|
$15.00 |
$15.00 |
| Operating Expenses |
|
691 |
791 |
|
832 |
2,954 |
|
4,727 |
10,403 |
|
Per boe |
|
$5.76 |
$7.13 |
|
$5.88 |
$9.04 |
|
$9.25 |
$9.50 |
| Gen and Admin |
|
1,097 |
1,352 |
|
1,470 |
3,085 |
|
4,855 |
10,403 |
|
Per boe |
|
$9.14 |
$12.19 |
|
$10.38 |
$9.44 |
|
$9.50 |
$9.50 |
| EBITDA |
|
3,157 |
2,724 |
|
3,596 |
9,366 |
|
14,436 |
30,222 |
|
Per boe |
|
$26 |
$25 |
|
$25 |
$29 |
|
$28 |
$28 |
Conclusion:
At 3.5x 2008E EBITDA, a conservative capital structure (at most 1x leverage), and a robust drillable inventory, we believe Arcan shares have been disproportionately punished. Looked at another way, ARN shares currently trade at approximately $35,500 per 2008E average BOE/day. At an average netback of $28 the payback period is 3.5 years, and a 7- year RLI assumption implies a 21% IRR, well over the company’s cost of capital.
For these reasons we feel that Arcan is worthy of a slight premium to its comparables, which trade at roughly 5x 2008E EBITDA. At 5.5x forward EBITDA, ARN shares would fetch $4.15, which implies a 66% return from today’s close.
Catalyst