This is a bit higher risk because it is in Colombia but the country has shown no hint of nationalizing the petroleum industry or taxing them to death
Stockhouse Ticker Trax is equity specific research (Canadian listed and market cap < $300 million) published every Monday to paid subscribers. Our free Friday column may feature companies previously featured to paid subscribers (with a minimum one month delay) or discuss topics of interest to the general investment community and relevant to overall portfolio management.
Suroco Energy (TSX: V.SRN, Stock Forum; 38 cents)
www.suroco.com
Shares outstanding: 130 million/Market cap: $49 million
Cash & receivables: $27 million /All debt including taxes: $20 million (financials filed Aug 20th)
2013 Cash flow estimate based on 1800 bopd: $31 million (24 cents/share) - note this is based upon my own calculations using SRN production targets and recent financials.
Production targets: 1500 bopd for 2012 / 1800 for 2013 / 2500 for 2014 (100% oil)
Region: Colombia / Large land position in proven oil regions
The valuation method used for Suroco is the same method I have employed very successfully with oil & gas companies in the past. For paid subscribers in 2012, I have presented Porto Energy (TSX: V.PEC), which has produced a 100% gain in two months and Manitok Energy (TSX: V.MEI), which has gained 60% in four months.
Suroco has a very small following and the fact they are based in Colombia makes that somewhat worse. However, the discounted valuation is strong and their netbacks (cash flow) in Colombia are much higher than we see in Western Canada. Western Canadian light oil cash flow has been averaging $36 to $42 per barrel. In the case of Suroco, $50 to $60 would not be uncommon (based upon past production).
In our efforts to identify oil companies with lower risk and strong growth potential, we are looking for:
1) Net debt levels at or near one times annual cash flow - SRN net debt because of their large cash and receivables is equivalent to zero - which is very attractive. This will allow them to fuel capital expenditures through existing oil production.
2) We want to find companies trading near two times annual cash flow. If their production growth stays strong they should be re-rated to three to five times annual cash flow. If SRN hits 1800 bopd in 2013 and oil stays in the $80's, they should generate approx. $50 in cash flow (netback) per barrel. Their 2011 operating netback was $61 per barrel based on average oil prices of $96.
Putumayo Basin of SW Colombia
Suroco is focused on three regions of Colombia but in the SW they hope to become one of the largest producers. Their success rate to date has been very strong and they have three development blocks with various working interests: 75,614 acres (50% W.I.), 90,263 acres (15.8% W.I.), and 58,070 acres (49.5% W.I.)
Within the Putumayo Basin they have 90,263 acres of the Suroriente Block. While their working interest is low at 15.8%, they have consistently hit big wells here. Estimated oil-in-place is up to 140 million barrels at Cohembi (within the Suroriente Block). They are implementing Western Canadian oil exploration standards and technology in Colombia and within Cohembi will start a large waterflood program in 2012 to help recover a large portion of the estimated 140 million barrels of oil. It is realistic to expect 10% to 20% recovery of total estimated oil-in-place...
Already within Cohembi they are having tremendous success. Cohembi-5 was drilled in the spring and hit a high-quality oil column of sand that was 23 feet (the total column was 77ft with no water contact). This was very similar to three previous test wells. In late April Cohembi-5 was put on production at 1,177 barrels of oil per day (171 bopd net to Suroco).
Cohembi-7 was put on production this summer at 1,322 bopd (a huge well by North American standards). Cohembi-4 started drilling June 13th and it was announced July 4th that this well at approx. 9000 ft encountered the same high quality oil bearing sands as the next closest well, Cohembi-3 located 1.2 km away. This is also located 3.2 km from discovery well Cohembi-1.
Suroco is proving that they know how to find and produce oil in the region but their current challenge is getting the infrastructure in place to handle the volumes. This is part of their focus for 2012. Tanks and trucking are available but that also brings up operating costs until pipelines and oil batteries (processing and storage facilities) can be built.
Country risk
This country has been very stable but like so many South American regions, political protests are as common as Sunday Church. The government of Colombia is very supportive of foreign mining and oil exploration but the rural people are poor and expect a piece of the pie.
In December 2011, Suroco saw this first hand when some roads were blocked near their Suroriente block. This affected oil transportation from their storage facilities. It was short lived but could have rattled nerves (although their stock didn't react this time).
If you don't mind the occasional risk of road blocks or the volatility associated with that, then the current valuation of SRN in the 30-cent range is very attractive.
Conclusion
Suroco's balance sheet and cash flow valuation are strong. If they continue to have the same drilling and exploration success, their production targets for 2013 should be easily achieved. If they are able to use that substantial cash flow to replicate similar success in their other regions, then this will grow into a decent sized oil company.
We always run the risk of falling oil prices but so far the outlook for oil remains positive.
An economic slowdown in Europe affects oil but at the same time the Chinese middle class is in the hundreds of millions and growing. All of these people want vehicles as a status symbol so the demand for oil will remain strong. In Beijing alone they have five million vehicles on the road and each month hold a lottery system for registrations. When I was there in early May the registration demand was five times higher than what was available in the lottery system.
Offset this with civil unrest and threat of military action we've seen (and continue to see) in oil producing countries and a strong case can be made for continued high oil prices.
Side note:
The middle of August Suroco released an operations update and a few things were important to note.
1) They hit on their Cohembi 11 appraisal well. Production at 240 barrels per day was very strong by Canadian standards but only 1/5th of the other wells they have hit in the same field. It is still important because:
a) This was targeted using historical 2D seismic (which validates their old data)
b) This was the far outer edge of their field and beyond their 3D seismic shoot
c) Based on the column of oil they hit (and location), this well discovery increases the total oil column height for that large field from 94 to 148 feet. This can have a significant impact on total known reserves within the field.
2) With completion of Cohembi 11, drilling will now focus on field where they believe the majority of the oil exists and is the source of the big wells (1000 plus per day) they have hit in 2012.
Suroco has varying working interests (percentage ownership) in Colombia and within the Suroriente block it is only 15% after royalty. However, the wells in this block are 100% oil and so far they have encountered little to no water during oil production - this is extremely important because water can be expensive to separate and dispose of.
In addition, many of the wells to date are big (1000 barrel per day plus) so a 15% working interest is very lucrative because even 150 bopd can generate almost $3 million per year in pure cash flow.
Based on my cash flow forecast for 2012 and 2013, this current trading range is a very attractive valuation. If Suroco is producing 2500 bopd in 2014, they would be generating almost $45 million per year in cash flow (at current commodity prices). With the same share structure the stock would be worth at least $1.
Long story short, this is a bit higher risk because it is in Colombia but the country has shown no hint of nationalizing the petroleum industry or taxing them to death. Should that risk surface, a person would simply sell the position.
The risk/reward on Suroco appears most attractive in the 30-cent range.
Their latest Powerpoint presentation is available here:
http://www.suroco.com/docs/2012-09-07_Investor_Presentation.pdf
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Disclosure: Danny Deadlock owns 30,000 shares of Suroco Energy (TSX: V.SRN).
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