Sent from a friend, so no guarantee this is in full or entirely representative of Scotia thoughts. 

Surge Energy (SGY, Sector Outperform)

Beats Investor Expectations (we think) with 1.5x Recycle Ratio; Hard Not to See SGY as Severely Undervalued at $3.50/sh 

Reserve Highlights: Reserves of 46 MMboe imply a 46% increase YoY (29% per share, non debt-adjusted). RLI of 14 years 2P on 9,000 boe/d. FD&A costs of $23/boe 2P, implying a 1.5x recycle ratio. Recycle ratio is ~$30/boe. Booked 2P FDC of $257 MM is 2.4x 2013 CF. Mgmt noted recycle ratios of 2.8x at Valhalla, 2.2x at Nipisi (suggesting that Nipisi has been a success, contrary to investor concerns over type curve performance). 

NAV: SGY has a booked NAV of $732 MM 2P BTAX, which is ~80% higher than their EV of ~$400 MM. Mgmt estimates their 2P NAV at $8.21/sh (>2x current trading). The 1P NAV is estimated at $5.29/sh. Interesting to note that >80% of SGY asset value come from Valhalla, Silver, Nipisi (not Windfall or Spearfish). 

Good News: SGY estimates that CFPS increased >30% YoY. Mgmt highlighting that production increased from ~6,000 boe/d to ~9,000 boe/d, or 21% per share YoY. Further, the reserve update suggests that SGY is now trading at or near PDP NAVPS and low-4x 2013 EV/DACF. Very, very cheap. To put numbers around it, SGY's PDP NPV 10% value is $366 MM and the EV is $400 MM, so investors are essentially paying PDP reserves; if the shares don't appreciate, this sets up for a fairly obvious takeout opportunity for a buyer (particularly as capital/production is focused on fewer assets this year). 

Capital Efficiency: Including acquisitions, SGY spent $292 MM last year. Given 3,000 boe/d of production adds on average YoY and ~2,000 to 2,500 boe/d of declines, the implied capital efficiency is ~$55,000/boe/d on average YoY. The exit to exit numbers would be better (low-$40,000/boe/d estimate, as previously noted by our Sales Desk). 

Mgmt Update: CEO back at work (recall, brief medical leave, investor speculation he would not come back appears incorrect). 

Ops Updates: Valhalla updates positive. Drilling southern end of pool (well delayed from YE 2012) and northern extension of pool realized positive results (peak IP30 rate 1,570 boe/ keeping with prolific results to the south). Completion pending on a well that is 2 sections north of existing northernmost well. Implies that production numbers through 1H 2013 will be supported by high rate Valhalla well additions. Admittedly, these wells do decline fairly quickly and this will require ongoing drilling by SGY to maintain production and grow into YE 2013, but the near term production performance looks intact. Batch of 7 Spearfish wells onstream late Q1 2013. 

Our View: The reserve numbers from SGY are solid (not exceptional, but respectable) results. This is certainly better than the disaster scenario that capital markets have priced into SGY at $3.50/sh. We drew a line in the sand at $4/sh and indicated that we thought SGY was a very compelling buy below this level. We have had inbound critiques of this view, largely based on feedback that Junior value stocks are irrelevant (e.g. there is simply no buyer universe for deep value Juniors unless they are growing). Taking a step back, F&D costs of $23.70/boe for SGY are likely to be top quartile for oil weighted producers. SGY has traded down to ~4.3x 2013 EV/DACF on our numbers, amongst the lowest trading multiples in our entire domestic E&P coverage universe (including both Intermediate and Junior firms). Recall one of our "10 Themes" earlier this year, investors don't need to chase value, they can buy companies that have already demonstrated results that are trading at cheap values. We think SGY fits this criteria. The capital efficiencies on production adds were challenging, but the shares have been cut in less than half. We were positive before today and we're MORE positive now, because the "risk on reserve announcement" has now passed. While SGY has lower netbacks than pure light oil peers, the recycle ratio at 1.5x still demonstrates value creation. We think this will be around a median result, for a company trading in the bottom decile of the peer group.

Our Sales Desk has learned to be cautious of energy value investments as this is where we've made our biggest mistakes in the past, but looking at SGY and LRE at the bottom of this chart (and probably PRY as they provide more data to public markets), it is hard not to see the opportunity to make money from current prices. We do think that investors can make money this year buying firms that are down heavily with pre-existing positive results...consider looking at LEG, TGL, BNK, SGY, LRE as examples. We would be buyers of SGY even if the stock rises 10% on today's news (there is a lot of room on SGY at present).