Pace Oil & Gas PCE
December 15, 2010 - 9:51am EST by
john771
2010 2011
Price: 7.70 EPS -$0.30 $0.33
Shares Out. (in M): 48 P/E N/A 23.3x
Market Cap (in $M): 366 P/FCF 5.6x 3.2x
Net Debt (in $M): 163 EBIT 34 121
TEV ($): 529 TEV/EBIT 7.1x 4.3x

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Description

Pace Oil & Gas was formed in July 2010 through the merger of Midnight Oil & Gas (a high growth junior company) with the upstream producing assets of Provident Energy Trust. The objective is to use the cash flow from the ex-Provident fields to finance the development of the ex-Midnight resources. 80% of the Pace shares were distributed to Provident shareholders and have weighed on Pace's valuation as the company has yet to develop its own identity and investor base. The company's current low cash flow valuation gives little credit to its growing oil production, abundant drilling opportunities, and potential long-term benefit from a rebound in Natural Gas.


BASIC FACTS


Symbol

TSE:PCE

OTCBB:MDOEF

Basic Shares Outstanding

47.5 million

Options

3.5mm with $8.16 average strike price

Warrants

None

Basic Market Cap

$366mm (after secondary)

Average Daily Volume

0.2mm shares

Enterprise Value

$529mm (after secondary)

Major Shareholders

Insiders 3%

Website

Home Page


Investor Presentation


Investor Contacts

Fred Woods, President and CEO

Phone: (403) 303-8505

Email: fwoods@paceoil.ca


Judy Stripling, Executive Vice-President and CFO

Phone: (403) 303-8502

Email: jstripling@paceoil.ca



COMPANY BACKGROUND


The investor presentation provides a good introduction to Pace operations so I wont repeat the same information. Some comments, observations, and explanations:


  • Pace reserves and net present value of future production were reassessed at 6/29, the effective date of the combination, using external forecasts of future oil and gas prices. For example the 2011 AECO gas price was forecast to average $5.30. On page 6 of the presentation Pace provided an internal estimate of reserves and PV10 value using price forecasts available at 9/30. Pace believes that the borrowing capacity on its credit line will not change significantly when reassessed by the banks using 12/31/10 data. In contrast, the most recently calculated reserves and PV-10 values of most peers were as of 12/31/09 using a 2011 AECO forecast of $6.79. Peer Reserves and PV-10 will be significantly lowered as of 12/31/10 and some firms are likely to have their credit lines squeezed. They can probably raise new equity in the current market, but this prospect makes their shares unattractive right now.


  • Pace has a very large land position with possibly 10 years inventory of drilling locations. The company has the opportunity to grow through development rather than grow through acquisition.


  • Pace operations are relatively diverse. The market currently seems to pay higher valuations for simpler stories (a Cardium oil play, a Bakken oil play, a Montney gas play, and so on). Fred Woods of Pace argues those stories work well for brokers, but are not the best way to run a business. In fact Midnight was a more exciting story, but financing its high growth potential at a high cost of capital during the bear market lost money for shareholders.


  • Pace resource plays are relatively undeveloped. For example, at the Haro Pekisko play in NW Alberta the company is still building local infrastructure and has not yet perfected a well development strategy. Results from the Winter program should provide analysts and investors with enough information to begin valuing the company on an NAV basis instead of simply proven reserves and current cash flow.


OPERATING & FINANCIAL DATA


Pace exceeded guidance for production levels in the first quarter after its formation and reaffirmed guidance for the current quarter. The company is on track to deliver attractive cash flow in 2011 and 2012 without any bold assumptions about development success or commodity pricing. I excluded first half 2010 results because they were distorted by various impacts of the amalgamation.


PACE OIL & GAS OPERATING & FINANCIAL DATA


3Q10 Actual

4Q10 Estimate

2011 Estimate

2012 Estimate






Daily Production





- Natural Gas (mmcf)

46.4

46.0

51.0

51.0

- Oil (mbbl)

4.4

5.1

6.8

8.4

- NGL (mbbl)

0.3

0.3

0.3

0.3

BOE (6:1)

12.4

13.0

15.5

17.2






Realized Price





- Natural Gas ($/mcf)

$3.69

$3.75

$4.50

$5.00

- Oil ($/bbl)

$68.57

$75.00

$79.00

$79.00

- NGL ($/bbl)

$47.09

$51.51

$54.25

$54.25






Income Statement (all in $mms)





- Oil & Gas Sales

$44.7

$52.2

$283.9

$341.0

- Royalties

-$8.0

-$10.0

-$54.7

-$67.5

- Other Revenues

$0.0

$0.0

$0.0

$0.0






- Operating Expense

-$17.4

-$18.0

-$85.0

-$94.1

- Transport Expense

-$2.0

-$2.1

-$10.0

-$11.2

- G&A

-$3.5

-$3.6

-$14.2

-$15.7

- Interest Expense

-$1.6

-$1.7

-$6.8

-$6.8

- DD&A

-$22.8

-$22.8

-$91.3

-$91.3






Pretax Income

-$10.6

-$5.9

$22.0

$54.4

- Tax

-$2.4

-$1.6

$6.2

$15.2

Net Income

-$8.2

-$4.2

$15.8

$39.2






EBITDA

$14.6

$19.4

$120.8

$153.2

Cash from Operations

$12.3

$17.7

$114.0

$146.4

Capex

$9.1

$28.0

$100.0

$100.00






Share Price (12/14/10)

$7.70

$7.70

$7.70

$7.70

Average Market Cap ($mms)

$308.2

$337.0

$365.9

$365.9

Debt - Working Capital ($mms)

$157.0

$162.5

$148.5

$102.1

Enterprise Value ($mms)

$465.2

$499.5

$514.4

$467.9

EV/EBITDA (annual)

8.0

6.4

4.3

3.1






EV/EBITDA Fair Value



6.0

6.0

Target Share Price



$12.13

$17.20



A reasonable cash flow multiple generates a 2011 price target of $12.13.


Analysts and investors like to value resource plays by multiplying the number of potential wells by the NPV per well and a "risk" factor. It is very likely that in 2011 more information will facilitate this type of evaluation of Pace's properties and a higher price target may become reasonable.


NATURAL GAS COMMENTS


Analysts seem to agree that 1) Natural Gas is the cheapest fuel for many major markets (e.g. electricity and transportation), 2) it is relatively clean, and 3) natural gas production is a terrible investment. I am not trying to call a bottom for Natural Gas pricing, however I believe positive developments have not been reflected in market prices:


  • Demand is surging. Aggregate US consumption rose 4.0% in the 12 months ending 9/30/10.

     

  • Imports are falling. Aggregate US gas imports fell 2.6% in the 12 months ending 9/30/10

     

  • Natural Gas consuming businesses are thriving. Write-ups this year have highlighted the benefits of cheap natural gas in production of chemicals and fertilizers. In Canada, oil sands production using natural gas generated steam should double within 5 years due to major new projects and expansions.

     

  • The US Natural Gas drilling rig count is declining, particularly for dry gas (without NGLs). The heavily hyped Haynesville Shale has accounted for 50-100% of the surge in US Natural Gas production in the past two years. Haynesville wells are expensive to drill and have steep decline rates. Haynesville leases are expensive and typically have high royalty rates. The number of rigs drilling the Haynesville has now fallen 20% from its 2Q high and will continue downward.


Pace has substantial legacy production from natural gas fields that could be expanded in a higher price environment and very high resource potential in Alberta's Deep Basin. Alberta is a great location for development of new resources due to a favorable royalty structure, excellent existing infrastructure, and an established base of knowledge in seismic data, well logs, and workers.


RISKS


Pace does not have high operating or financial leverage, but lower commodity prices could bring the fair value of the shares down to or below the current price.


Pace's new resource plays are not yet at a stage where the company can give detailed guidance about number of potential wells, reserves, and NPV per well. If the numbers are reasonable then information flow in 2011 will boost the stock because the value will then be obvious. If the numbers are disappointing then the shares will languish.


Canadian energy companies frequently cite weather as an excuse for disappointments. The spring can be too warm because the ground thaws and turns to mud and no work can be done. The summer can have too much rain and no work can be done.





Catalyst

CATALYSTS

  • Increasing oil production

  • Increasing natural gas prices

  • End of tax loss selling

  • End of shareholder turnover

  • Shift from a cash flow valuation towards a NAV valuation as investors become more comfortable with resource play potential

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    Description

    Pace Oil & Gas was formed in July 2010 through the merger of Midnight Oil & Gas (a high growth junior company) with the upstream producing assets of Provident Energy Trust. The objective is to use the cash flow from the ex-Provident fields to finance the development of the ex-Midnight resources. 80% of the Pace shares were distributed to Provident shareholders and have weighed on Pace's valuation as the company has yet to develop its own identity and investor base. The company's current low cash flow valuation gives little credit to its growing oil production, abundant drilling opportunities, and potential long-term benefit from a rebound in Natural Gas.


    BASIC FACTS


    Symbol

    TSE:PCE

    OTCBB:MDOEF

    Basic Shares Outstanding

    47.5 million

    Options

    3.5mm with $8.16 average strike price

    Warrants

    None

    Basic Market Cap

    $366mm (after secondary)

    Average Daily Volume

    0.2mm shares

    Enterprise Value

    $529mm (after secondary)

    Major Shareholders

    Insiders 3%

    Website

    Home Page


    Investor Presentation


    Investor Contacts

    Fred Woods, President and CEO

    Phone: (403) 303-8505

    Email: fwoods@paceoil.ca


    Judy Stripling, Executive Vice-President and CFO

    Phone: (403) 303-8502

    Email: jstripling@paceoil.ca



    COMPANY BACKGROUND


    The investor presentation provides a good introduction to Pace operations so I wont repeat the same information. Some comments, observations, and explanations:


    • Pace reserves and net present value of future production were reassessed at 6/29, the effective date of the combination, using external forecasts of future oil and gas prices. For example the 2011 AECO gas price was forecast to average $5.30. On page 6 of the presentation Pace provided an internal estimate of reserves and PV10 value using price forecasts available at 9/30. Pace believes that the borrowing capacity on its credit line will not change significantly when reassessed by the banks using 12/31/10 data. In contrast, the most recently calculated reserves and PV-10 values of most peers were as of 12/31/09 using a 2011 AECO forecast of $6.79. Peer Reserves and PV-10 will be significantly lowered as of 12/31/10 and some firms are likely to have their credit lines squeezed. They can probably raise new equity in the current market, but this prospect makes their shares unattractive right now.


    • Pace has a very large land position with possibly 10 years inventory of drilling locations. The company has the opportunity to grow through development rather than grow through acquisition.


    • Pace operations are relatively diverse. The market currently seems to pay higher valuations for simpler stories (a Cardium oil play, a Bakken oil play, a Montney gas play, and so on). Fred Woods of Pace argues those stories work well for brokers, but are not the best way to run a business. In fact Midnight was a more exciting story, but financing its high growth potential at a high cost of capital during the bear market lost money for shareholders.


    • Pace resource plays are relatively undeveloped. For example, at the Haro Pekisko play in NW Alberta the company is still building local infrastructure and has not yet perfected a well development strategy. Results from the Winter program should provide analysts and investors with enough information to begin valuing the company on an NAV basis instead of simply proven reserves and current cash flow.


    OPERATING & FINANCIAL DATA


    Pace exceeded guidance for production levels in the first quarter after its formation and reaffirmed guidance for the current quarter. The company is on track to deliver attractive cash flow in 2011 and 2012 without any bold assumptions about development success or commodity pricing. I excluded first half 2010 results because they were distorted by various impacts of the amalgamation.


    PACE OIL & GAS OPERATING & FINANCIAL DATA


    3Q10 Actual

    4Q10 Estimate

    2011 Estimate

    2012 Estimate






    Daily Production





    - Natural Gas (mmcf)

    46.4

    46.0

    51.0

    51.0

    - Oil (mbbl)

    4.4

    5.1

    6.8

    8.4

    - NGL (mbbl)

    0.3

    0.3

    0.3

    0.3

    BOE (6:1)

    12.4

    13.0

    15.5

    17.2






    Realized Price





    - Natural Gas ($/mcf)

    $3.69

    $3.75

    $4.50

    $5.00

    - Oil ($/bbl)

    $68.57

    $75.00

    $79.00

    $79.00

    - NGL ($/bbl)

    $47.09

    $51.51

    $54.25

    $54.25






    Income Statement (all in $mms)





    - Oil & Gas Sales

    $44.7

    $52.2

    $283.9

    $341.0

    - Royalties

    -$8.0

    -$10.0

    -$54.7

    -$67.5

    - Other Revenues

    $0.0

    $0.0

    $0.0

    $0.0






    - Operating Expense

    -$17.4

    -$18.0

    -$85.0

    -$94.1

    - Transport Expense

    -$2.0

    -$2.1

    -$10.0

    -$11.2

    - G&A

    -$3.5

    -$3.6

    -$14.2

    -$15.7

    - Interest Expense

    -$1.6

    -$1.7

    -$6.8

    -$6.8

    - DD&A

    -$22.8

    -$22.8

    -$91.3

    -$91.3






    Pretax Income

    -$10.6

    -$5.9

    $22.0

    $54.4

    - Tax

    -$2.4

    -$1.6

    $6.2

    $15.2

    Net Income

    -$8.2

    -$4.2

    $15.8

    $39.2






    EBITDA

    $14.6

    $19.4

    $120.8

    $153.2

    Cash from Operations

    $12.3

    $17.7

    $114.0

    $146.4

    Capex

    $9.1

    $28.0

    $100.0

    $100.00






    Share Price (12/14/10)

    $7.70

    $7.70

    $7.70

    $7.70

    Average Market Cap ($mms)

    $308.2

    $337.0

    $365.9

    $365.9

    Debt - Working Capital ($mms)

    $157.0

    $162.5

    $148.5

    $102.1

    Enterprise Value ($mms)

    $465.2

    $499.5

    $514.4

    $467.9

    EV/EBITDA (annual)

    8.0

    6.4

    4.3

    3.1






    EV/EBITDA Fair Value



    6.0

    6.0

    Target Share Price



    $12.13

    $17.20



    A reasonable cash flow multiple generates a 2011 price target of $12.13.


    Analysts and investors like to value resource plays by multiplying the number of potential wells by the NPV per well and a "risk" factor. It is very likely that in 2011 more information will facilitate this type of evaluation of Pace's properties and a higher price target may become reasonable.


    NATURAL GAS COMMENTS


    Analysts seem to agree that 1) Natural Gas is the cheapest fuel for many major markets (e.g. electricity and transportation), 2) it is relatively clean, and 3) natural gas production is a terrible investment. I am not trying to call a bottom for Natural Gas pricing, however I believe positive developments have not been reflected in market prices:


    • Demand is surging. Aggregate US consumption rose 4.0% in the 12 months ending 9/30/10.

       

    • Imports are falling. Aggregate US gas imports fell 2.6% in the 12 months ending 9/30/10

       

    • Natural Gas consuming businesses are thriving. Write-ups this year have highlighted the benefits of cheap natural gas in production of chemicals and fertilizers. In Canada, oil sands production using natural gas generated steam should double within 5 years due to major new projects and expansions.

       

    • The US Natural Gas drilling rig count is declining, particularly for dry gas (without NGLs). The heavily hyped Haynesville Shale has accounted for 50-100% of the surge in US Natural Gas production in the past two years. Haynesville wells are expensive to drill and have steep decline rates. Haynesville leases are expensive and typically have high royalty rates. The number of rigs drilling the Haynesville has now fallen 20% from its 2Q high and will continue downward.


    Pace has substantial legacy production from natural gas fields that could be expanded in a higher price environment and very high resource potential in Alberta's Deep Basin. Alberta is a great location for development of new resources due to a favorable royalty structure, excellent existing infrastructure, and an established base of knowledge in seismic data, well logs, and workers.


    RISKS


    Pace does not have high operating or financial leverage, but lower commodity prices could bring the fair value of the shares down to or below the current price.


    Pace's new resource plays are not yet at a stage where the company can give detailed guidance about number of potential wells, reserves, and NPV per well. If the numbers are reasonable then information flow in 2011 will boost the stock because the value will then be obvious. If the numbers are disappointing then the shares will languish.


    Canadian energy companies frequently cite weather as an excuse for disappointments. The spring can be too warm because the ground thaws and turns to mud and no work can be done. The summer can have too much rain and no work can be done.





    Catalyst

    CATALYSTS

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