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  BXE: high risk, and potentially high reward

BENJ GALLANDER, BEN STADELMANN, and PHILIP MACKELLAR

Sunday January 29, 2017

So, how are your oil and gas stocks doing? For many investors, this question has resulted in grumbles, blank stares or even tears since 2014.

At Contra we have not been spared. One of our holdings is Calgary-based Bellatrix Exploration, which focuses mostly on natural gas in Alberta.

After buying at $3.79 in 2010, Ben sold half of his shares in 2014 at $9.69 before buying them back in 2014 at $3.46. Alas, this purchase was premature. Since then, he doubled his stake at $1.51 but has slipped further underwater.

In a bid to avoid ruin and live to see the next commodity cycle, Bellatrix made significant changes during 2016. In the summer, it sold a 35&nbps;percent stake in its Alder Flats gas plant to Calgary-based Keyera for $113 million. This reduces its ownership in the facility from 60 percent to 25 percent. Though Bellatrix is no longer the majority owner, the company will maintain a gas processing access agreement.

Management also sold a $47 million stake in certain assets to InPlay Oil, and in December sold more Albertan assets for $80 million.

The good news is these transactions have improved the outfit's odds of survival and further reduced total net debt. The bad news is Bellatrix — like many of its oil and gas brethren — sold good assets at low prices. While many organizations in distressed situations deem sales to be “non-core,” that is certainly not the case here.

The enterprise also modified its capital structure. In July, it raised $80 million through a bought deal, which consisted of $50 million in convertible debt and $30 million in equity at a price of $1.20 a share. This was followed up with a flow-through private placement for proceeds of $10 million. These actions have diluted existing shareholders but, like the asset sales, have improved the chance of survival.

Though good progress has been made, dangers remain. A major question mark is that chief executive officer Raymond Smith took a medical leave of absence in November. If he does not return, the corporate direction may take an unexpected turn. This adds a measure of uncertainty — and markets dislike vagueness.

There is a risk of delisting from the NYSE, too. If the stock cannot consistently close above $1 (U.S.) by early February, the exchange may move it off the big boards. To avoid this, top brass may consider a dreaded share consolidation. We think this is unlikely, however, and losing the NYSE listing may not be so bad because the U.S. trading volumes are lower than in Canada.

Moreover, Canada has provided Bellatrix with ample access to capital markets. Instead, the bosses will likely file documents and receive another six months to regain compliance given the listing is just a few cents from the $1 mark.

During the first half of 2016, Orange Capital, the now defunct U.S. investment firm run by former Bellatrix board member Daniel Lewis, sold millions of shares rapidly as that enterprise unravelled. This put downward pressure on Bellatrix and makes the insider activity for 2016 look horrendous despite a few purchases by other board members and managers.

In 2017, Bellatrix expects production growth of 10 percent, anticipates funds from operations of $100 million (Canadian) and will increase capital spending by roughly a third to $105 million. To manage the risk associated with natural-gas prices, two-thirds of its projected 2017 production has been hedged at $3.36 per thousand cubic feet.

In the longer term, the Alder Flats expansion is on budget and on track to start in mid-2018, and through 2019 management's goal is to grow production by 33 percent to over 42,000 barrels of oil equivalent per day.

Though we continue to hold the shares — and the company's chances of endurance have improved — owning it is not for the faint of heart. On the one hand, it could more than double quickly, as some of its peers have done, and in the long term could once again be a double-digit stock.

On the other hand, it could dilute existing owners into oblivion, sell off its crown jewels and future growth at fire-sale prices, or go bust. While the old adage “high-risk, high-reward” is overused, it captures the nature of this situation nicely.


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