Canada Connection: Calgary's oilpatch
The global turmoil in credit markets is not only creating havoc among large investors, it is now making it especially difficult for Canadian small-cap companies to raise new capital.
And that is nowhere more clear than in Calgary’s oilpatch, where many junior energy companies are financially stretched, says Scott Carscallen, a specialist in Canadian small caps at Toronto-based Howson Tattersall Investment Counsel Ltd.
Howson Tattersall manages the Saxon Mutual Funds group. The firm's parent company, Saxon Financial Inc. (TSE: SFI.TO) has more than C$13 billion under management.
After a recent summer tour in the Calgary oilpatch, Carscallen says it is no secret that many small-cap energy companies are stretched financially.
"They have exhausted their bank lines of credit as a result of over-aggressive spending and are experiencing production declines as they lack the necessary capital to support their exploration programs," he notes in his review of the small-cap oil industry in July.
As well, he says, the juniors are more heavily geared to natural gas production and have been hurt by the lower commodity price.
If that were not enough, the proposed new Canadian tax regime for income trusts, including oil and gas royalty trusts, "has lowered the market value of these juniors as many were looking to the larger royalty trusts to acquire them at premium valuations."
(Income trusts in Canada became an attractive way for Canadian and U.S. investors to get higher returns because the tax liability flowed through to investors, lowering the higher taxes on the corporation while taxing individuals at a lower rate. However, the Canadian government has since moved to tax these income trusts at the same rate as corporations.)
Despite these setbacks, Carscallen still insists there are some interesting opportunities by looking for what he calls “quality names” that have strong balance sheets, a good inventory of low-to-medium risk projects and have low finding and production costs. As well, Carscallen says these quality companies trade close to their net asset value.
As far back as January, Carscallen said he and the firm were substantially adding to their energy weighting and would continue to do so. In all, the portfolio has 18 names in the energy sector to ensure diversification.
Two of their favorites are Breaker Energy LTD (TSE: WAV.A.TO) and Burmis Energy Inc. (TSE: BME.TO).
Breaker Energy
This Calgary-based company, says Carscallen, has been successful in growing both its reserves and production per share. Its production is balanced between oil and gas. Breaker has a strong balance sheet. This provides it with the flexibility to support both its drilling program and its acquisition spending.
"Its management has a good track record in both aspects of its growth strategy," says Carscallen.
The stock, he says, trades at a slight premium to net asset value. "But I consider that this premium is warranted given that this is a high quality junior," says Carscallen. The company is projecting that its production will grow by some 67% in 2007. The consensus cash flow per share estimate is C$1.38 for 2007 and C$1.68 for 2008.
Breaker closed at C$6.10 on Monday. The 52-week high is C$6.70, while the 52-week low is C$4.76.
Burmis Energy
Calgary-based Burmis Energy "has many of the attractive features of Breaker," notes Carscallen. Like Breaker, Burmis has been successful in growing its reserves and production and achieving this growth with "modest finding costs” while its operating costs are lower than many of its competitors.
This company has a "fairly high exposure to natural gas and this commodity price has been weak of late," he says, but it is still increasing production, with a 32% hike estimated for 2007.
The consensus cash flow per share estimate is $C0.80 for 2007 and C$1.01 for 2008. Burmis Energy has recently been trading at about C$2.34 a share. During the past year Burmis had moved between C$3.63 and C$2.05.
Other small caps favored by Carscallen
Outside the oilpatch but still among Canadian small caps, Carscallen says he likes Dalsa Corp. (TSE: DSA.TO), which for the past year has traded between C$9.26 and C$14.50. Dalsa closed Monday at C$10.25.
Headquartered in Waterloo, Ont., Dalsa designs and makes digital imaging products used for industrial inspection systems. "A key growth area for this company is inspection systems for flat panel displays," Carscallen says. Dalsa also makes semiconductor components for the electronics industry.
Dalsa’s earnings “are highly cyclical and difficult to predict and this has weighed heavily on the stock," he says. Another downside for the stock, he suggests, is Dalsa's heavy development spending on its new digital camera designed for the motion picture industry, which “has yet to generate any material revenue and earnings for the company."
Nevertheless, Carscallen says the company has an "excellent" reputation with its customers and has good long-term growth prospects both in terms of new products and new markets.
"The stock trades at a fairly modest valuation," he says. The consensus EPS for Dalsa is C$0.57 for 2007 and C$0.86 for 2008. In 2006, it had earnings of C$0.62 a share.
Carscallen also likes Dorel Industries Inc. (TSE: DII.B.TO), which has fluctuated between C$25.00 and C$40.49 in the last 12 months, before closing Monday at C$28.21.
Dorel is a Montreal-based manufacturer of consumer products including ready-to-assemble furniture and children's products such as car seats as well as bicycles and scooters. "Its core juvenile products division is solid and the overall company has been a significant cash flow generator" although its furniture division “has been hard hit by low-cost Chinese competition,” he says.
Dorel's management has restructured this division, says Carscallen, which should begin to show improved results and is introducing new products to expand its leisure line.
"This stock is inexpensive," he says, noting it trades at roughly book value.
