Transglobe energy long thesis improves significantly – transglobe energy corp (nasdaq tga) seeking alpha electricity video ks1


As I go over the two main news releases since my last publication, I’m forced to conclude that the investment case for Transglobe Energy (NASDAQ: TGA) has significantly improved. The first release being the latest earnings numbers, and the latter being an operations update.

It’s been a while since my first write-up on TGA. Since then, my core position has not changed. I continue to believe that TGA is the best long investment for 2018, as it could easily double. Now, with new clarity on oil prices and the geopolitical and industrial situations influencing them, I believe that the company could very realistically reach the net present value of 2PP of roughly $4.80 if Brent averages $70 this year. Even though the NPV of 2PP was calculated with a Brent price of $55-60. It is therefore implied that TGA’s fair value lies significantly beyond the $4.80 price target given above. However, this valuation allows room to discount certain negatives about the company’s performance, like its exploration results.

Additionally, I believe that 2019 will be the year where the years of global underinvestment in drilling projects will start to rear their ugly head. This would continue to sustain, if not accelerate, the price of Brent and thus TGA’s fair value. Key Focus – Free Cash Flow – Remains extremely favorable

The earnings release didn’t garner much attention from investors, as the stock barely reacted to it. This was surprising, since TGA’s net cash position jumped to $47 million from $21 million on a quarterly basis. Based on the current share price of $1.61, the company’s cash position is about 42% of its market capitalization. This increase in cash occurred with Brent averaging $53.25 ( page 13).

It’s unclear how much the free cash flow yield would increase if Brent averaged $70. This is not as easy as multiplying the current cash flow yield with the increased realized price, as it’s very possible that expenditures increase as service companies seek their piece of the pie. Suffice to say that the increase will be substantial. I am currently working on a detailed earnings model and may or may not decide to publish it publicly. Based on the work currently done, the model indicates that a 40% increase (with respect to my earlier estimation) in FCF yield would be probable.

In absolute terms, the (yet unfinished model) indicates that TGA could generate as much as $60 million FCF this year, putting the company’s total annual cash generation almost on par with its debt levels. Secondly, it would mean that TGA’s cash balance would surpass its debt obligations. Production and drilling

Production was on track in Q1’18, according to the company’s operations update. A main reason for my investment in TGA was the fact that the company is now able to sell all of its oil, something it wasn’t able to do previously. This was due to a contract with a third party which scheduled 3 cargo liftings for TGA in 2017. TGA now reports that 4 cargo liftings will be scheduled in 2018. Additionally, the company will continue to sell 200,000-300,000 barrels per quarter to EGPC.

In terms of drilling, 1Q18 was a success for TGA. The company drilled two wells, which were both successful. The big question is, of course, whether there has been any progress on the South Alamein concession. For those who do not recall, the South Alamein concession is a potential game changer for the company. In my first publication, I wrote:

The Egyptian assets also have potential to significantly boost production. For example, this year, the company regained access to its South Alamein acreage in Egypt which was previously under control of the military. One of the wells, Boraq 2, produced an initial production rate of 1,600 bpd. This is, of course, a major development for a company that was producing 12.8k bpd in 3Q17.

Those of you who have been following this story closely know about TGA’s initial attempt to increase scale so that the 1,600 bpd could be explored. TGA has identified additional prospects that could provide sufficient scale. However, the company is still keeping investors in suspense, as it plans to explore these wells in late 2Q18 at the earliest. A word on the price of oil

The surprises in the oil market – both geopolitical and industrial – have caused the oil price to surge above $70. It is clear now that, even with shale producing at record rates, the world is still in a deficit. Additionally, Venezuela’s oil industry is collapsing. This is evident as inventories continue to draw, with the latest draw coming at -1.1 million barrels versus consensus of -0.5 million. Even though the prior week showed a build of 3.3 million, the overall quarter has been a net draw. This despite refineries being in maintenance season and thus processing a significant amount of oil less.

According to the latest IEA weekly report, refineries operated at 92.4% of their total capacity. Seasonally, the first quarter is always the slowest for oil. The general expectation is that demand will pick up in the second half of the year.

As if the above situations weren’t enough, the US 10-year treasury is now floating and flirting with the 3% level. The 10-year treasury is notoriously correlated with rising commodity prices and is used as a metric to gauge the direction of commodity prices.

The chart above relays the worldwide capital expenditure in the upstream oil industry per year. As we can see, capex has declined significantly since 2014, with capex in 2016 and 2017 being 38% less than that seen in 2014. Keep in mind that at the same time, demand has increased significantly. While shale has had technological improvements reducing the per barrel cost, it is a mere fraction of the global demand. The vast majority (over 90%) of production has seen per barrel cost more or less stagnant on a relative basis. As such, capex levels should realistically top that of 2014 instead of the current situation. Conclusion

The situation for TGA has improved significantly. In my opinion, it was a great investment at an average Brent price of $57-60. Brent is now hovering around $70 in refinery maintenance season. I expect oil prices to climb significantly in 2019, while at least maintaining the $70 level in 2018. My price target of $3 (a 100% return) seems far too conservative to me now, which is why I am increasing my price target to $4.80. Surprisingly, this price target would still appear to be significantly below the actual fair value and is thus considered conservative by me.