Stock Gumshoe is off today, observing the Labor Day holiday by partaking in as little labor as possible, so with the markets closed we thought we’d share an older piece with you today. This is a solution to a teaser that ran for quite a while this Summer, and we wrote about it in a Friday File for the Irregulars about five weeks ago. What follows is excerpted from that Friday File and has not been updated or revised — do note that since this article was published, the dividend has been announced and the first quarterly dividend paid (six cents, post-consolidation, so an effective yield of about 5%) and the stock consolidation has taken place (the consolidation turned ten shares into one share, so instead of being a 46 cent stock it became a $4.60 stock).
And now, on to our excerpt — this originally ran as part of the Friday File on July 26:
The basic pitch for Keith Kohl’s favorite Bakken stocks has been running for a long time, recommending some of the more appealing “juniors” in the Bakken area in recent years, but I’ve never seen this particular one teased before.
Here’s the intro that caught my eye in a recent issue of their free Wealth Daily newsletter:
“There’s a new player in North Dakota’s Bakken shale oil field.
“This small, undiscovered company has 11,000 acres in America’s most prolific oil field.
“The company has just completed two new Bakken wells. And the initial production (IP) rates were pretty good.
“Over the next couple of years, this company will drill at least 17 more Bakken wells.
“By the end of this year, it will be pumping 4,000 barrels of oil a day.
“The stock sells for just $0.46 a share.
“But get this: It’s about to start paying its shareholders a 5.8% annual dividend.”
And yes, it’s that dividend that caught my attention. Having a very low share price in penny stock range like this doesn’t mean a company has to be teensy, but most of them at this price are — and it’s pretty rare for these companies to be profitable, let alone pay a dividend of part of those earnings. So which stock is it this time?
That letter was actually signed by Briton Ryle, but the letter links to the standard “Three Bakken Stocks Under $10” pitch that they’ve been using for a while to promote Kohl’s Energy Investor … which, like so many newsletters, has cut its price to the magical discount level of $49 to get people interested (though it will renew at $99 in future years). They never hinted at the details of this third tiny stock in the current version of the ad, though, so I was pleased to catch these hints from Ryle as we try to figure out what the stock is.
Here’s the last bit of clueiness:
“… news of this 5.8% dividend has not been announced yet.
“The dividend was approved at a recent shareholder meeting. And the company has included a 2013 dividend in its most recent investor presentation.
“But the dividend has not been ‘officially’ announced…
“Once that happens — and it could literally be any day now — I think these 46-cent shares will move higher.
“My colleague here at Angel Publishing, Keith Kohl, covers this stock.
“Keith says this stock will easily trade above $1 before the year is out. I believe him.
“By the end of next year, as production grows, this stock could be pushing $2 a share — a 334% gain.”
I can’t resist the notion of tiny, growing, unknown stocks that pay good dividends — I can often resist buying them, of course, but I can’t stand not knowing their name. So who is this one?
Thinkolator sez: Arsenal Energy (AEI.TO, AEYIF on the pink sheets)
Arsenal is a company with a market cap of about $65 million, so it is indeed tiny — and the share price is down quite a bit from their highs (it’s been near a dollar a couple times since the financial crisis, but has been bouncing around between 40-45 cents in recent months). They are a small Bakken producer with some decent results from recent wells, though they have also been putting their cash flow back into exploration and new drilling in Canada, and they have proposed turning the excess cash flow from those US assets into a dividend (which did show up as a potential 5.8% yield in their recent presentation). They’re also planning a 10:1 share consolidation (also called a “reverse split”) that they hope will get the stock up to the $4-5 range and get them taken seriously by investors who like that dividend (and by institutional investors who typically won’t or can’t buy “penny stocks”, though most institutions generally wouldn’t buy a company this small anyway).
Though small, it looks like Arsenal is trying to become what many of the old Canadian royalty trusts turned into, a corporation that reports “funds from operations” instead of earnings, and that focuses on pushing cash flow out to shareholders. Which lots of folks like, certainly, but which also brings on a fair amount of risk if you’re a very small company that may not be all that steady or predictable on the “cash generation” front.
The company is actively producing oil, and exploring, but it does seem likely that formal announcement of the dividend and the date for the reverse share split will be catalysts to move the stock — it’s just not clear what that move will be. Usually, starting a dividend helps a stock … and usually, having a reverse split hurts a stock. All else being equal. They have proposed paying out 10% of their trailing cash flow as a dividend, and the last slide of their Annual General Meeting presentation speculates at a 5.8% yield level for that payout, but they haven’t actually announced the dividend yet. Likewise, from what I can tell all their proposals were passed at the annual meeting, including the share consolidation, but they haven’t announced the record date yet.
So let’s look and see what Arsenal’s all about, shall we?
Well, first of all — it is a good match for the tease. Even beyond the 5.8% “unannounced” dividend (they have mentioned the dividend plan in press releases and in that presentation, just not declared the amount formally yet). They are planning on pumping more than 4,000 barrels of oil per day (boe/d) by the end of the year, for the second quarter they reported 3,750 boe/d and they say their run rate at the end of the year should be 4,400 boe/d. That’s about 3/4 oil and 1/4 natural gas. And their latest press release about those two successful wells recently brought on production in North Dakota did note that they have 11,000 net acres in the Bakken (though the full presentation calculates the acreage at 10,140).
So the basics are there — the argument is that they’re a stable producer, even though they’re very small, and their drilling locations in key areas of the Bakken are producing oil predictably and profitably, so they should be able to sustain a cash payout. They do have more than 17 potential drilling locations in the Bakken, they have 27 net locations in the Bakken and another 70 or so in their other two key areas, medium-heavy oil in Southeast Alberta and natural gas and NGLs in the Cardium formation.
Most of those Bakken wells will be developed over the next three years, with a few taking longer, and Bakken wells are characteristically very low producers after the first year, so I’m not sure what the economics will be for a company that’s paying out their cash flow in dividends instead of reinvesting in acquiring new drilling targets — it will depend quite a bit on how profitable the Cardium stuff ends up being, I guess, or on oil prices over the next few years, because if they’re paying out a substantial portion of cash flow we have to consider the Bakken stuff a pretty rapidly depleting asset.
Though that’s part of the argument from Kohl: That the Bakken is going to be even bigger than we think, and they’ll keep finding ways to generate more production from these areas, whether it’s hitting lower formations or stimulating or fracturing differently, or whatever… so their net acreage of 10-11,000 acres will end up being worth more than you’d calculate based on their current drilling inventory.
So to tell you the truth, I’m still on the fence a bit on this one — I’m tempted to wait and see if the stock declines after they finalize the reverse split, since that usually scares off small junior stock investors who are terrified of the kinds of reverse splits that destroy shareholder value over time (that would be the penny stocks that keep falling and burning through cash, and keep consolidating their shares so they don’t drop below a penny). For a company like this that is generating good operating cash, and should be at a solid level of profitability at least for the next several quarters thanks to their Bakken and Alberta wells and the improving oil price Bakken producers are getting, I think it’s quite likely that a dip on fear of the reverse split could give us a chance to buy the stock at a discount over the next month or two.
At this price, it seems like the valuation is pretty fair and the underlying fundamentals are improving with continued production increases, but since they only have really a few years of oil drilling inventory and the wells deplete pretty fast it strikes me that you have to make some pretty big assumptions to think it will get to a dollar this year or two dollars next year — with perhaps one of those assumptions being that investors will go gaga for the dividend when it’s announced. I’m just not completely confident that there’s a plan for replacing their reserves and keeping the train moving, but I’m still just getting to know this stock and I am not an expert on valuing little producing oil companies.
One risk of waiting, certainly, is that it’s possible that the dividend will be a bigger positive than the consolidation will be a negative. But for me, though I was tempted for a bit as I worked through this one, I’m going to wait and see how it shakes out with the upcoming announcements. Those consolidation and dividend announcements will probably indeed be coming soon, so there are likely catalysts to move the stock … but with current investors already knowing about these coming catalysts, and with strong insider ownership, I am a bit nonplussed by the fact that the stock ha been quite weak in the 10 weeks or so since they started talking about dividends and share consolidation.
On the other side of that argument, it’s worth noting that there has been pretty heavy and consistent buying from a couple insiders over the last two months — which is usually a good reason for optimism. If the stock comes down to the high-30s, maybe 35-38 cents per share, I’d be more urgently tempted to take a nibble … as it is, I’m still a bit tempted but I’m going to be patient and see if I can take some time and understand their longer-term potential first.
And now back to the present — I still don’t own shares, the stock has jumped around a bit during the dividend and consolidation talk but is still in roughly the same neighborhood, and I prefer a $5 stock to a 50-cent stock if all else is equal. The company is still optimistic about substantial growth in cash flow as of their last quarter, you can see their press release here. If you’ve got an opinion on this one, or any other favorite oil plays in the Bakken to share, feel free to shout ’em out with a comment below.
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