“Ingenious E&P Company Profits When Natural Gas Prices Rise … or Fall!”

What's Robert Rapier's pick, led by a Modern "Wild Bill" Mountain Man?

By Travis Johnson, Stock Gumshoe, September 29, 2015

This ad caught me eye as I was browsing a bunch of energy-related teaser picks recently — I’ve been starting to get tempted by the MLPs and the other energy infrastructure plays of late, and will probably be writing about some of the teaser picks for those sorts of companies in the near future… but this one’s a little bit different.

And it’s not an infrastructure company, not really — it is a natural gas producer, so there’s theoretically more commodity price risk than with a pipeline company (though, as a lot of the pipeline companies are finding, they get some commodity risk too — particularly when their contracted customers, the oil and gas producers, can’t afford to pay them for gathering systems or longer-distance transport), but Rapier’s teaser implies that this company will be profitable regardless of what natural gas prices do.

And we know that natural gas will get used, whether it’s to heat homes or generate electricity or, in a few years, get turned into Liquefied Natural Gas (LNG) and shipped off to an energy-deficient customer overseas (Japan, Korea, etc.), and prices can only drop so far before the market corrects itself and cuts into production… so is this one worth a look?

Well, we’ll at least find out the name of the stock for you.

Starting with the clues — Rapier has a nice storytelling bit to lead us in (though, frankly, he probably had nothing to do with actually writing the ad letter — his publisher has used almost exactly this same story to tease probably the same stock for Canadian Edge about five years ago — more on that in a bit), here’s a bit of the intro:

“Call this story ‘A Tale of Two Mountain Men’…

“Ebenezer William, or ‘Wild Bill,’ was a colorful 19th century adventurer, a living legend in his day, who trapped, prospected and guided pioneers across the rugged Canadian Rockies.

“Today, another mountain legend roams the same wild region. He’s the colorful ‘ramrod’ of what is likely the most efficient North American energy producer of them all.

“The company sells their natural gas for a ridiculous TRIPLE the production cost. They’ve maintained a staggering 34% average return on investment for the last 15 years. (By comparison, Exxon’s average ROI over the last 5 years is 13.2%.)

“Everyone from the chairman on down displays a fanatical devotion to their shareholders’ best interest. Get in now and stake your claim on a bonanza in capital gains… plus generous distribution checks arriving in your mailbox like clockwork.”

Now, it so happens that you could have pretty quickly come across the name of this stock yourself if Rapier had included Wild Bill’s last name in the tease… but that would be too easy, right?

Here’s a bit more, getting into teasing the actual company:

“Out in the wilds of Western Canada, there’s a brilliant E&P outfit defying one of the basic laws of economics—they profit when the price of natural gas rises… or falls.

“They’ve perfected a technique that allows a single wellhead to tap into multiple layers of gas simultaneously, boosting production dramatically and very cheaply.

“Stunningly low production costs have powered the company’s consistent profitability. A $1,000 grubstake invested in 1998 would be worth $461,530 today.”

Sounds impressive, right?

Well, that number is very close to what the company has posted in its presentations a few times over the years, and it’s not too far from what the reality would be for a longtime shareholder — had you bought shares in 2000, which is as far back as the data goes in my system for this one, you would be sitting on 13,000% gains.

Of course, a lot of that is due to the strong performance when the stock was very small and was generating 100%+ annual gains with some regularity — over the last ten years, the total return (distributions reinvested) is about 60% (or 50% if you’re a US$ investor, thanks to the exchange rate)… still pretty good if you consider that the broad energy index (as represented by the XLE ETF) is only up about 30% over that timeframe. But 50-60% total return in ten years doesn’t get anyone shivering with greed, which is why you see those numbers like “$1,000 turned into $461,000” … even though those kinds of returns are really only possible when you identify companies that are fairly small and destined for long-term greatness, and your chances of being wrong at that point, early in the growth of a business, are much greater than they are when the company’s management and strategy have been proven.

So what’s the secret “mountain man” company? It’s Peyto Exploration and Development (PEY.TO, PEYUF OTC in the US), which started life with that same name, then spent five or six years as an Energy Trust when those were the flavor of the week for investors in the late-2000s, and is now a regular corporation again.

Peyto is indeed one of the stalwart stocks of the Alberta Deep Basin gas production area — and they do produce natural gas very efficiently, and own much of their own infrastructure to help them manage costs. They are also, though no longer a royalty trust, very focused on shareholder returns, including cash returns in the form of dividends (the current yield is between 4.75-5%,