Strathcona Resources, a rare add to the NCP energy alpha fund.
Why we added it and where we see an opportunity
Strathcona Resources is new company to the public markets after acquiring publicly traded Pipestone Energy via a share issuance but otherwise isn’t new at all as it was privately held and operated formerly by the Waterous Energy Fund. Prior to being held by the Waterous Energy Fund it consisted of multiple publicly traded entities rolled up counter cyclically by Adam Waterous beginning in 2017 during a period of peak market weakness on both Canadian energy and oil markets overall.
Strathcona Resources trades at a material discount to other oilsands producers currently being valued at only $40,000 boe/ev despite having one of the deepest reserve profiles in the energy space at 38-years. According to the company’s latest profile, their reserve are also being valued at a material discount to other Canadian E&P’s by an average of 50-60%, including shorter cycle names such as Crescent Point which normally see a wide variation between lower decline names such as MEG.
A hidden medium catalyst with Strathcona is that there is significant and lower-risk predictable organic growth on the horizon beginning in 2024 as the company plans to increase incremental oilsands output by 25,000 boe/d with a target of 2026 at a cost of aprox. $25,000 per boe. NCP analysts forecasts this to increase the value of the company by at least $1 billion dollars using $80 oil and $16 WCS differentials without factoring in further gains on operational synergies including a new waste heat recovery unit to lower natural gas and diesel costs with 16 new megawatts of on-site power production, which also qualifies the company for free money from the government’s climate initiates.
Strathcona Resources currently has $2.8 billion dollar debt against $4.4 billion of common equity, 90% of which is held by the Waterous Energy Fund making the stock incredibly illliquid. Out of the 10% available, likely only 5% or less may be floating around publicly traded markets lately given that Riverstone held 40% of all Pipestone shares and GMT Captial held another 18%. NCP does not anticipate that either party would be interested in selling at current valuation although with time, a secondary offering may be possible from Riverstone if the stock remains illiquid and commodity outlook improves. Until then, we think you should take advantage of large swings of this illiquid set-up to acquire in small increments until liquidity frees up, likely with the prospect of further acquisitions, possibly done during counter cyclical weakness.
Given energy is currently falling out of favor fast due to a correction which appears likely to last at least deep into 2024, the likelihood of a “re-rate” seems far-fetched for most mid-cap names making the allure of torque to debt reduction more attractive to us than trying to improve on the multiple front. Strathcona Resources offers predictable debt repayment with a steady and low decline asset base, making equity upside appreciation far more likely even if the multiple remains low as it is now. In fact, when it comes to “re-rates” I would argue we are still seeing larger funds pull out of energy than enter, and more examples of private companies seeking to liquidate themselves into public markets rather than public markets buying back their own shares and taking themselves private. Strathcona is an example of that with Riverstone recently selling its large controlling stake in both Hammerhead and Pipestone and Strathcona taking itself from private to public. Debt to equity gain is far more compelling than a re-rate dream on out of favor equity!
In a nutshell, while we are moderately bearish on oil for the next 6-months, we think that it is possible to see $80 if OPEC continues its output cuts and inevitably at some point, global macro conditions improve. Our main thesis on Strathcona is the discount valuation gap to other oilsands producers and the fact we expect WCS differentials to compress in 2024 with the start-up of the Transmountain expansion, opening up Canadian oilsands output to markets beyond the Midwest. We are comfortable factoring in a $15- differential on WCS by YE 2024, although any output gains from Venezuela on their heavy blend must be watched carefully. We also note that while condensate, a critical component often making 30-40% of a bitumen barrel is trading at par or a slight discount to WTI, that is not always the case. Higher demand for egress likely puts C5+ back into a premium at some point, which offers Strathcona an advantage as they recently acquired the Pipestone asset to keep the condensate value chain internal by accessing their own product for blending.
Bottom line, we see Strathcona Resources as peak out of favor given the extremely negative market perception of Pipestone Energy. Factor in some illiquidity, scarcely known company profile amongst investors, and a recent oil market crash dominated by every day negative recessionary headlines into what is normally considered peak tax-loss selling and the weakness becomes more compelling to take advantage of. Oh, and a key company insider recently spent $250,000 this past week on shares too.
Thank you for reading and as always, if you have any questions or comments please leave them in the comment section.
Yours truly,
Roger Lafontaine
Partner, Head Trader & Research Analyst, Nugget Capital Partners