The Globe and Mail

  Fishing for value nets a risky energy play


Thursday, May 1, 2008

After your latest case of sticker shock when gassing up the car, you naturally reckon that somebody must be making buckets of money, and you want in on the action. If, like us, you are allergic to paying high prices for popular stocks, regardless of how enticing the sector might be, then the trick is to find a play that has fallen through the cracks yet might be worthy of interest.

The Globeinvestor website's nifty stock filter tool provides a way to conduct such a search. The array of parameters on the Advanced Filter menu can be a bit daunting, but the Quick Options show some examples of how to build complex queries.

For example, the "Fishing for Value" filter features nine classic value-investing ratios. They all seem quite logical, except perhaps the requirement of a "three-year positive price change." When on the hunt for a bargain, it seems reasonable to consider stocks that have gone down in value over the past few years.

Adjusting this filter to look at only oil and gas companies, and removing the price change parameter results in a list of 15 securities that fit the constraints. Not many — which is to be expected, given the strength of the petroleum sector. Six of these are income trusts with distributions that are generous, but of dubious sustainability, particularly if prices for crude moderate. Upon examination of the remaining enterprises, one sticks out with numbers that far exceed the filter's fairly stringent criteria.

Pebercan sports fancy ratios with price/earnings of 4.5, debt/equity of 0.09, and a price/book of 0.79. The one-year return on equity comes in at 21.2 percent, while three-year profit growth is 20.1 percent. What's the catch?

Pebercan may have fine fundamentals on paper, but investors in the Montreal-based junior have to accept political risk, as these oil wells are in Cuba, which entails a number of complications, to say the least. For starters, Pebercan sells all production to Cupet, the Communist country's oil and gas agency. The offshore oil is heavy, difficult to extract and has a high sulphur content. Refining capacity on the island is limited, and the U.S. trade embargo makes export problematic. The average price received in 2007 was $42.61a barrel, far below that of benchmark Brent sweet crude.

The Cuban government has been routinely late in paying its bills, and Pebercan's balance sheet typically shows a large accounts receivable item, totalling $93.7 million at the end of 2007, of which $61.4 million was past due. An agreement last November has resulted in the collection of $30.8 million of this receivable. With Cuba currently only able to supply 47 percent of its fuel needs, the nation will probably remain strapped for cash. It manages by importing the rest of its fuel from Venezuela in exchange for the services of 31,000 medical personnel. Michael Moore must be impressed.

Another challenge for those hoping to buy a piece of Pebercan is its very poor liquidity due to its tiny float. There are 74.6 million shares outstanding of which 82 percent is controlled by chairman Michel Reybier and French shipping firm Maurel & Prom. It's no wonder that on "the top-10 fund report," only one name appears: Fidelity NorthStar-A, with a paltry holding of 25,000 shares. Given that the stock trades in the $2 range, this position will not be breaking Fidelity's bank.

But a fund manager's misery is not necessarily echoed by the individual investor, and one Contra Guy managed to accumulate a sizable position with patient buying. Aside from the fundamentals, he likes that the company is partnered with Sherritt International, a key player in Cuban resource development. The political risk is certainly acknowledged, but acceptable given that even the most intransigent regimes eventually change.

The U.S. Geological Survey estimates that the waters north of Cuba contain between 4.6 billion and 9.3 billion barrels of oil and about a trillion cubic feet of natural gas. This suggests that at some point the Caribbean nation will be known for more than Cohiba Robustos cigars and a nice place to spend March break.