SPND - Spindletop Oil and Gas

[Radio Free Cash Flow]

I wrote up a tiny but profitable and well-capitalized E&P company, Spindletop Oil and Gas. http://otcadventures.com/?p=300

 

The company has a lot of things going for it.

 

1. Overcapitalized. Market cap is $15.5 million. Net cash is $7.6 million.  Almost 50% of market cap in cash and equivalents.

2. Cheap. Trades at 6.4 times trailing earnings and EV/EBITDA is 2.6. Market cap is 90% of book value. P/E net of excess cash is 3.3.

3. Long track record of success. Average ROE of 19.7% over the last ten years and built book value per share from $0.40 to $2.24 along the way. Long-term holders have realized huge returns.

4. Strong management incentives. Husband and wife are CEO and chief counsel and own 77% of shares outstanding, market value of which is over 25 times their annual combined compensation.

 

Risks

1. Subject to unpredictable commodities prices and the natural gas glut.

2. Key man - Depends on CEO's skill at capital allocation and acquiring reserves for fair value or less.

3. Nanocap company and highly illiquid stock - float of only around 1 million shares

 

I think there's plenty of upside, and the company's asset value supports the price. However, I know very little about the oil&gas industry and what sort of ratios, trends, accounting conventions/shenanigans to look for.

 

Can anyone shed some light and/or tell me why I am either onto something or dead wrong here?

 

[ItsAValueTrap]

1- The real estate is carried on the books for less than what it's worth?

 

In 2011, the RE generated $211k in pre-tax income.  At a cap rate of 6%, the RE would be worth $3.5M versus book value of $1.667M.  I'm not entire sure what the appropriate cap rate should be; their real estate has seen declining income for some reason.  Also, cap rates are much lower than 6% right now in today's low interest rate environment.

 

If you really wanted to get into it, you could strip out the RE from the oil&gas operations since they are two different beasts.

 

2- Contango's earliest presentations are helpful for understanding the industry:

http://www.contango.com/investor/events.htm

 

3- One of the problems with E&P stocks is that reserves may be inflated.  Reserves are an *educated guess*.  Unfortunately, small changes in underlying assumptions can have a cumulative effective that grossly overstates reserves.  The now bankrupt ATP Oil & Gas is an example of what's wrong with independent oil & gas stock.

 

VIC has 4 different long writeups on ATPG common (and one on the bonds):

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/2552

 

-negative free cash flow is usually a red flag

-you need to be careful if a company has high levels of proved undeveloped reserves (PUDs)

-constant broken promises of production targets is a red flag

-constantly raising equity is a red flag

-selling royalties to its suppliers is dubious and is a sign of desperation (if you're a supplier, you are used to getting paid in cash and aren't normally a buyer of royalties)

 

I don't see any of these red flags with Spindletop.  But in general, it's stuff like ATPG that makes me wary of the independent oil & gas stocks.  Ken Peak of Contango points out that the sector has a poor track record of profitability.

 

4- This may be a nice find???

 

5- You probably want to buy commodity companies when the commodity price is low, not high.  Natural gas prices are below the cost of most players' all-in production costs... so I am incredibly bullish on it long-term.  The question is when they will go up.

 

6- Ideally, you would try to guess the market value of the company's producing assets and land.

[Tim Eriksen]

I have owned SPND in the past.  I sold out about a year ago. 

 

Regarding the real estate, it is the corporate office and they rent some of it out.  I would not strip out the whole value unless you are doing a liquidation/sale valuation.  Obviously they have to have offices somewhere if they are a going concern. 

 

Looking at recent earnings you do have some one-time items.  Both Q1 and Q2 have large income from one time farmout agreements.  They are equal to more than half of pre-tax profit in the first six months.  I would also note the tax credits.  It is normal for a small O&G company to have a low tax rate, but not usually a negative one if they have been around a while.  Thus I think the true PE is no where near 6.4.  It is closer to the mid to high teens.  Net of cash it is still reasonable. 

 

The other concern is G&A is quite high on a per mcf (or boe) basis.  This is not unusual for small firms and if they were to sell some of it could be eliminated, but it does eat into profits significantly.  They do have a great balance sheet.  The biggest positive is that they would benefit significantly from any rise in natural gas prices.  A $1 increase in natural gas is $0.10 per share in pre-tax income. 

 

A similar but slightly oilier company would be TVOC.  RSRV and TRKX are not liquid.  I think TRKX is the cheapest.  They do post limited financials on their website but only sends full year end financials to shareholders.         

[claphands22]

Havent looked at this company is ages, but I remember being annoyed the CEO & wife owned another O&G company that did business with SPND. It is hard to know for sure if SPND gets a fair shake for the services it charges to the other company & the services the other company charges them.

 

Definitely an interesting company, stupid illiquid though.

[Radio Free Cash Flow]

Thanks for the responses! Definitely a lot to think about. I appreciate the help.

 

I've looked at Reserve before and they seem to be top notch operators, and they pay healthy dividends. TRKX is very cheap, but probably not investable with the gigantic bid/ask.