Description

Pan Orient Energy (POE or the Company) is in many ways the perfect little oil stock for today’s uncertain energy market. The downside is protected as a result of a cash-rich and debt-free balance sheet with net cash that is about equal to POE’s market cap. It sells its oil at a premium price which, along with low production costs, allows POE to generate significant cash flow even at today’s prices. And the company is forecasting increased production in the back half of 2020 and 2021. 

Yet, this all flies below the radar due to accounting rules and the fact that 2019 saw significant exploration spending on a project that the Company is no longer operating. The result is a very strong investment setup where you can buy an excellently positioned oil company at an enterprise value significantly below 1x EBITDA. An increase to a still below-industry average multiple of 2.5x (on a cyclically low 2020 EBITDA figure) would result in a share price of $1.30 and a return of greater than 100% without any meaningful recovery in oil prices.   

I will discuss each of these points in turn. 

POE is listed on the TSX-V; all figures are listed in Canadian dollars unless specified otherwise except for Brent oil prices which are stated in U.S. dollars.

Cash-Rich and Debt-Free

At March 31, POE had no debt and $26.4M in working capital plus non-current deposits. This includes cash plus deposits of $29.5M. Including its 50.01% share of the working capital and non-current deposits of Pan Orient Energy (Siam) Ltd. (POS), the Company’s 50%-owned operating subsidiary, POE has total adjusted working capital and deposits of $32.2M. 

POE sold 49.99% of the shares of POS to Sea Oil Public Company of Thailand in 2015 for $42.5M USD and POE now owns 50.01% of POS. POE's CEO Jeff Chislom is also the CEO of POS and POE controls the entity. 

Oil Sales at a Premium 

POE is Canadian-based and listed, but it is not your typical Canadian E&P company with restricted pipeline access and discounted sale prices. POE’s sole operating asset is an onshore oil concession in Thailand (Concession L53), located 60 kilometers west of Bangkok, owned through POS. POS entered into a new oil sales agreement effective this past February. The company had forecast that the new agreement would result in oil sales at just under the price of Brent. February sales came in right on target at a 2% discount to Brent, while oil sales in March and April came in at premiums to Brent of 13% and 22%, respectively, providing a valuable buffer to POE during the worst of the oil price bust. (May 14 PR, page 2 and Q1 2020 MD&A page 8.) 

Low Production Costs

Combined production, operating and transportation expense for POS was about $9 per barrel of oil in 2019 and $9.20 per barrel of oil in Q1 2020. I want to reiterate that these figures are in Canadian dollars. So, we are talking about a combined cost of less than $7 per barrel on a USD basis. POS also pays a government royalty of 5% on its oil sales. After deducting $2.20 per barrel of G&A at the POS level, POS should generate about $28.70 per barrel at an annual average $30 USD Brent price and about $40.85 per barrel at an annual average $40 USD Brent price.  

Figure 1: Author estimates for 2020 EBITDA at $40 and $30 average annual Brent oil price

After deducting $2.1M for corporate costs at the company-level, this results in Company EBITDA of $12.6M at an average 2020 Brent price of $30 and $18.8M at an average 2020 Brent price of $40.

Increasing Production in 2020 and 2021

Annual production for POS is forecast to increase significantly this year with the major step-up in production occurring in the second half of 2020. Forecast production (POE’s 50% share) is about 1,400 bopd for 2020, which would represent a 32% increase over 2019. The Company’s early forecast for 2021 is for another increase to about 1,550 bopd.

Figure 2: Thailand Production Forecast (February presentation, page 10)

Accounting Rules and Past Results Obscure the Company’s Value

POE accounts for its interest in POS as an equity investment. Under equity accounting, POS’ revenue and expenses do not show up on the Company’s income or cash flow statements and its cash is not listed on the Company’s balance sheet. To see the details of POS’ results, one needs to review the financial statement notes, the MD&A or the Company’s presentation. While these results are clearly illustrated, a computer-based stock screen focused on EBITDA or cash flow would not pick up on POE.

For example, in 2020, the company’s share of POS’ revenue was $29M and EBITDA was $23M. After deducting current income taxes and cap ex, free cash flow was $11M.  (December 31, 2019 MD&A, pages 7 and 14.)

But all a computer screening POE’s financial statements would see is $4.9M of other income, specifically income from investment in Joint Venture (Income Statement), a $34.1M entry under non-current assets for Investment in Joint Venture (Balance sheet), and a reduction of cash flow from operating activities of $4.9M on the cash flow statement reflecting the separate nature of POS (which is more than offset by a $6.6M Dividend from investment in joint venture in cash flows from investing activities but the screens are certainly not looking there). 

Disappointing exploration results announced in late 2019 may also be obscuring the value of POE’s current operations. The Company struck out on a highly anticipated exploration well drilled by Repsol, its 51% partner, on an Indonesia oil prospect. The well cost POE $15M and resulted in a $28.6M impairment expense. While clearly a major disappointment, POE has withdrawn from Indonesia operations and there will be no further spending on this prospect. The major capital spending drag will not recur this year or in the future.  

Free Cash Flow

As stated above, POS generated $11M of FCF for the Company last year but POE would likely be about FCF break-even at $30 average Brent in 2020. POE is forecasting capital expenditures this year of $10M-$12M which would be funded through Thailand cash flow. The program includes the drilling of five exploration wells (including sidetracks), three development or appraisal wells, one water disposal well (which should materially reduce production costs) and a number of workovers. At a $40 average Brent price, POE could bring in $2M-$3M of FCF this year even while it significantly grows its production and funds exploration drilling. 

Going forward, free cash flow should increase substantially. In January 2021 all exploration lands outside of an existing discovery Production License will expire. For this reason, the 2020 capital/work program is focused on exploration drilling - at the end of 2020 everything worth drilling will have been drilled. (February 2020 presentation, page 11.) 

With an early production forecast of about 1,550 bopd and a 50% reduction of capex (due to the end of exploration drilling), POE could bring in $9.5M of free cash flow next year at a $50 USD Brent oil price ($6M FCF at $40 Brent). 

Figure 3: Author Forecast for 2021 free cash flow at annual average Brent oil price of $50.

Note that forecast incorporates a Thailand corporate income tax rate of 50% charged against an income base that approximates free cash flow.    

Valuation

Without a lynchpin for near to medium-term oil prices, it is difficult to appraise the value of POE but it is clearly significantly higher than the Company’s net adjusted working capital of $32M, about where POE is currently trading. Any valuation is a moving target that fluctuates with oil prices. What I have done, therefore, is to use low current oil prices in forecasting POE’s results to create a conservative valuation of the Company. To the extent that the oil supply/demand picture sustainably changes in the coming months, one can revisit the forecast of results and re-calculate the valuation. 

If I place a 2.5x EBITDA multiple on 2020 EBITDA of $15M based on a $35 average Brent price (midway between the $30 and $40 estimates used above), I am effectively placing a below-industry level multiple on a cyclically low EBITDA figure for a debt-free low-cost producer. However, POS does pay a very high tax rate of 50% in Thailand so a lower-than-normal EBITDA multiple might be called for. (On the other hand, the asset would be much more valuable in the hands of a company with other Thailand exploration and development plans to offset against the POS cash flow, and a sale to such a company could result in a higher value where POE and the buyer share in that upside.)  

A 2.5x multiple of EBITDA would result in an enterprise value of $37.5M and a market cap of about $70M which equates to $1.30 per share based on 53.4 million shares outstanding at March 31, 2020. That would also equate to a multiple of just under 4x my forecast for 2021 free cash flow. This value is somewhat lower than the December 31, 2020 net present value (at a 10% discount rate) of POE’s 50% share of Thailand proved plus probable reserves of $44M. That valuation used much higher than current oil prices ($65 Brent for 2020 with increases thereafter) but also did not account for potential additional reserves anticipated by the Company given the early stage development of the 2018 L53-DD discovery and exploration drilling to be carried out in 2020. 

I should note that POE also owns a majority interest in Andora Energy Corporation, which in turn owns a 50% interest in the Sawn Lake SAGD oil sands project. POE has made significant investments in Andora in the past but fully impaired the investment in Q1 and plainly stated that there can be no commercial development of the project in the current energy environment. The project may well end up holding significant value in the next few years as Canadian oil pipeline capacity moves materially ahead of production and demand for oil returns to pre-pandemic levels. However, there are today numerous other assets in a similar position and I can’t see valuing this as other than a free option, albeit one with a payoff that is multiples of today’s market cap. 

All in all, I view the valuation of $1.30 per share as conservative though, of course, by no means certain. A sustainable shift higher in oil prices would significantly increase POE’s value.

Catalysts 

It is unlikely that POE’s valuable Thailand oil asset will remain hidden from sight for long. 

For one thing, the Company is buying back its shares in significant amounts. Over the past three months, POE has repurchased over 4% of its shares. In my view, and presumably the Company’s as well, each dollar spent on repurchases provides an extremely high return - in excess of 100% at current price levels and no lower than 30% at share prices up to $1.00 per share. I would view the Company’s balance sheet as very strong with $20M of net cash, leaving POE a lot of room for accretive repurchases. At times, the company goes into blackout periods relating to impending news releases where it does not buy back shares and the present may be one of those times as the Company was planning significant drilling in June. But I expect the buybacks to resume following any blackout as the Company just recently purchased shares at the $0.71 level. The buybacks tend to move the share price up but are also creating increased value on a per share basis at the same time. 

As a second potential catalyst, I note that POE has not been averse to selling assets in the past including another Thailand joint venture oil interest sold for $170M USD in June 2012 and 50% of its interest in POS itself for $42.5M USD in 2015. The Company paid significant one-time distributions to shareholders of $0.75 per share in 2012 and $0.40 per share in 2015 following those transactions. 

For better or worse, the Company’s various exploration projects have played out and even POS will have completed its exploration initiatives by the end of the year. What you have left is a cash box that should generate significant incremental cash through the operation of an ultra low-cost oil property or the sale of that property to a purchaser that could extract additional value from it. 

With a conservative appraisal of $1.30 in today’s low price energy environment and additional upside from higher multiples and higher cash flow in the event of increasing prices plus a free option on a permitted and tested oil sands property, POE offers investors strong prospects for a 100%+ return in the near-to-medium term. 

Catalyst

Significant share buybacks
Potential sale of Thailand property
Conclusion of exploration program at the end of 2020 leading to major free cash flow increase and capital returns
Positive results on planned exploration and development drilling 
Increasing oil prices

Risks

Major deterioration of Thailand production

Poor capital allocation of Thailand cash flow