Why Now: Canadian oil and gas producers are cheaper than they’ve been in a while. The Canadian dollar has slipped a bit more than 3 percent against the US dollar this year, hitting stocks’ values in US dollars.

Meanwhile, a shortage of North American pipeline capacity has hit producer earnings by trapping large quantities of oil north of the border and pushing down selling prices. And, in the past week or so, concerns about China’s economic growth have hurt commodity prices in general.

Worst hit of all have been smaller producers, who lack the scale to ride out the turmoil profitably. The quest for size quickly induced the former AvenEx Energy Corp, Pace Oil & Gas Ltd and Charger Energy Corp to join forces to form a new entity, Spyglass Resources Corp (TSX: SGL, OTC: PACED).

Initial investor reaction was skepticism, and even opposition from some shareholders who preferred the trio simply sell assets to bigger players.

As a result, Spyglass shares have generally performed poorly since the deal was consummated on Apr. 4, 2013, and are now sitting 75 percent off the 2011 highs of predecessor companies. Buy under USD2.25.

The Story

This month’s Big Yield Hunting recommendation is based on the expectation that gloom will lift as Spyglass Resources proves itself with its earnings numbers. That’s based mainly on the apparent quality of its long-life assets, hedge positions as released, generally solid cash and debt positions and, finally, narrowing oil-price differentials in Canada and rising natural gas prices in North America.

Realizing that goal may take some months. But with no debt maturities for the next two years, Spyglass has time to make things work.

And the bar for success is set very low, so it won’t take much of leap to beat it.

David: I think we should start by reviewing the past recommendations we still have open. After all, we did more or less clean house last month.

Roger: I think it bears repeating that the purpose of this service is not to find stocks to buy and hold for the long term.

Rather, we’re looking for unloved stocks that can give us huge gains, and the primary evidence they’re not liked is they yield more than 10 percent.

David: And we’re willing to live with the risk of taking losses, should these companies elect to cut those dividends to save cash.

In fact, sometimes the dividend cut actually produces share-price gains. Investors perceive the worst has happened, and the saved cash allows the recovery to begin.

Roger: Excellent segue to a brief discussion of one of our Open Positions that we’re still holding onto.

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) cut its dividend shortly after we recommended it. We held onto it on the premise that the cut was the nadir in the energy producer’s fortunes.

And I have to tell you, I feel a lot better about that decision now with the stock moving up a bit.

David: I think that’s more due to the rise in natural gas prices the past several weeks than anything to do with the company itself.

Roger: I agree. The fourth-quarter numbers announced in February weren’t really anything special, just the latest evidence management is playing it conservatively in light of volatile energy prices and the threat that price differentials between US Gulf Coast and Canadian oil will widen out again.

But it’s also a fact that our returns in high-yielding energy producers depend to a large degree on what does happen to energy prices.

Negative pricing trends burned Bonavista last year, particularly for natural gas liquids. Maybe starting this year we get a little payback.

David: Unlike the other high-yield energy we’ve recommended here, Bonavista is priced in Canadian dollars, and its dividends are paid in Canadian dollars too. That’s hurt this position this year.

Does that concern you going forward?

Roger: Absolutely. And to the extent that China’s growth does become a near-term worry for the stock market it’s quite possible the exchange rate will drop a bit more.

But let’s keep in mind that these are leveraged plays, and the Canadian dollar does ultimately provide us more leverage. That’s a big reason why we re-entered PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF).

David: That’s a stock that doesn’t seem to get a lot of respect. I thought management gave a solid first-quarter operations update this week: production on track, capital spending on target, less impact expected from the spring breakup season on output and, from all indications, reduced price differentials.

Yet the stock is actually lower since the news.

Roger: I think it’s clearly what happened to oil prices this week and, more important, what people fear slower growth in China might mean for black gold later in the year.

True, there is continued skepticism about the dividend, combined with selling momentum that’s still sustained by Petrobank Energy & Resources Ltd (TSX: PBG, OTC: PBEGF) shareholders divesting.

But there are some real positives here.

The insiders are really buying this one, and Bay Street really hasn’t shifted off its generally bullish stance, with 12 “buys” versus nine “holds” and just two “sells.”

Most important, the company appears to be generating plenty of cash to cover the dividend, meet capital spending needs and pay down debt.

The bear case is they won’t be able to keep doing that in 2013 if oil prices drop enough or if differentials between Canadian and Gulf Coast oil widen out again.

Unfortunately, there’s no way to really counter that view until PetroBakken announces first-quarter numbers, which isn’t expected until somewhere around May 22.

But the 12 percent-plus yield, the enduring skepticism imbedded in the current share price, the leverage to the Canadian dollar and the likelihood of continued solid results despite subpar market conditions make this an ideal Big Yield Hunting play in my view.

David: What about stop-losses? We’ve never used them before in this service. But couldn’t they help limit potential downside?

Roger: I think there are two problems with stops in these trades.

First, when you’re buying riskier stocks you’re by necessity dealing with selling momentum that often moves of its own accord. You might get taken out of a position before you have a chance to collect a single dividend, only to see a rebound on the next day’s trading. That’s particularly true of anything involving energy.

The other thing is some of these stocks are relatively thinly traded, at least in the US. That’s also a formula for getting stopped out, if you can enter the positions at all. What investors might want to do is set some mental stops–that is resolve to sell if a certain price level is breached.

I still prefer to focus on company developments to make those decisions. But it’s true that these are high-stakes trades, subject to big moves in either direction.

The best way to protect yourself is to not take too large a position in any of them. But whatever other steps investors want to take to get comfortable playing in this environment are probably good ideas.

David: BreitBurn Energy Partners LP (NSDQ: BBEP), Natural Resource Partners LP (NYSE: NRP) and QR Energy LP (NYSE: QRE) are all pretty liquid in the US, so you wouldn’t have at least that problem with setting stop-losses.

Roger: Yeah, and all of them have been doing reasonably well in this volatile environment for energy prices. I’m especially happy about Natural Resource Partners, as this has been a very tough environment for coal producers.

I think what’s kept these stocks stable–particularly relative to the Canadian positions–is the fact that they’re organized as master limited partnerships (MLP). MLPs are clearly quite popular now in the US for yield, safety and tax advantages.

And even MLP energy producers have been carried up in the buying momentum. I’m not entirely sure that’s a trend investors should really count on.

But paying a regular quarterly dividend has forced these MLPs to be very conservative with financial and operating policies, and by that I mean hedging out a good portion of their direct exposure to commodity-price swings.

David: BreitBurn has now raised its distribution for 11 consecutive quarters since reinstating it in February 2010. And I see management affirmed this week that it intends to raise the payout 5 percent a year going forward.

The company also put up some numbers to back that up, including what appears to be some really valuable hedges in place through 2017 and a robust oil-focused capital spending budget.

Roger: If there is such a thing as a safe stock in our lineup, my vote would go to BreitBurn.

Insiders are buying, and analysts are bullish, with 11 “buys” and four “holds.” It doesn’t quite yield 10 percent anymore. But anyone who buys up to our target will get there after a couple quarters of boosts.

In fact, I think we should raise our buy-under target on BreitBurn to USD21.

David: And leave PetroBakken and Bonavista the same I presume?

Roger: I think so. Let’s see some more numbers from Bonavista until we declare it a buy again.

I also think we leave QR and Natural Resource Partners as buys up to USD21 and USD22, respectively.

I don’t think they have the distribution growth in them that BreitBurn does. But QR gave what I thought was a nice analyst presentation this week. The efforts to boost oil focus are on track, both from drilling and accretive acquisitions.

And I didn’t realized it’s 100 percent hedged on expected oil and gas production through the end of 2014 as well as 87 percent hedged in 2015, 81 percent in 2016 and 64 percent in 2017. That’s definitely a formula for modest distribution growth, even if oil and gas prices take a real bath this year, which by the way I’m not expecting.

David: There’s been less hard news from Natural Resource Partners. My feeling is the recent price rise is due more to rising natural gas prices than anything else at this point.

Roger: I think you’re right.

The 36.7 percent increase in units held by insiders over the past six months is a big positive, but this one is going to follow coal prices, which in turn are going to follow natural gas.

I think Natural Resource Partners have a pretty stable business model, but I wouldn’t chase it above our buy target of USD22.

David: I want to point out one more thing to readers before we move on. BreitBurn, Natural Resource Partners and QR Energy are all master limited partnerships. That means you get a Form K-1 at tax time rather than a 1099, which is a bit more complicated.

Also, if you hold a lot of MLPs in an IRA there may be enough unrelated business taxable income (UBTI) to trigger a liability.

Roger: I think the rule of thumb on that is USD1,000 of UBTI across the entire IRA account. You do have to hold a lot of MLPs to approach that, and keep in mind that many MLPs actually generate negative UBTI.

But for investors who aren’t comfortable with grey area around tax time, these are probably best held outside IRAs.

David: I know you’re waiting for a comment from me on Australia’s Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF).

Clearly the concern about China is taking a toll on pretty much every mining company around the world. Even big copper producers are taking it on the chin, and this isn’t a big company. They’re not going to announce a dividend until next month, and the speculation is clearly that market forces are going to force a cut. It hit a new low today by the way.

Roger: A cut is clearly priced in at least. Do you want to keep it?

David: It’s a small mining company in an environment where even bigger players are getting taken out and shot. I still like the story, and I want to see the earnings when they’re reported next month.

But let’s make Aditya Birla a hold at these levels.

Roger: Fair enough. We are talking about high stakes here after all.

Lastly, our position in Windstream Corp (NYSE: WIN) is up a little less than 5 percent. But everyone who owns it should be fully prepared for volatility as their first-quarter earnings announcement gets closer. That’s going to happen on May 9.

And with short interest equivalent to 13.2 percent of the float, there’s certain to be a flood of bearish opinion and rumor to try to get a rise out of investors.

There are no guarantees that this company won’t really lay an egg when it does announce. But there’s also been no indication it will, either.

One other thing is that management has told analysts several times recently that the dividend is in no danger this year, so there’s clearly grounds for lawsuits if they’re forced to go back on that next month.

I think Windstream still has speculative appeal up to USD11.

David: So what’s caught your eye this month?

Roger: I think we should look at Canada again. The currency is cheaper than it’s been in a while, and energy stocks there are basically going begging.

One of the more interesting stocks there is Spyglass Resources Corp (TSX: SGL, OTC: PACED). This company, as you’ll recall, is the product of the merger of the former AvenEx Energy Corp with Pace Oil & Gas Ltd and Charger Energy Corp to accomplish one thing none of these companies could do on their own: gain needed scale to survive and compete in the oil and gas production business.

One of the costs was a dividend cut at AvenEx to the current rate of CAD0.0225 per month, and I think that took a bite out of its shares prior to the deal. But the new rate looks decently protected by cash flow, and it still equates to a yield of more than 13 percent at this price.

Let’s face it. Few people want to buy small Canadian producers at this point. But by merging, this company is much stronger than its former component parts.

David: I see Spyglass is 34 percent hedged on estimated crude oil production at CAD94.84 a barrel for the rest of 2013 and 41 percent hedged on its gas at CAD3.02 per gigajoule, which is roughly equivalent to the million British thermal unit measurement we use on this side of the border.

It’s also got 6 percent of 2014 oil hedged at roughly the same price and 25 percent of gas at around CAD3.58 per gigajoule.

That does appear to be a pretty good start toward supporting Spyglass’ capital program and dividend this year, and management seemed to indicate last week that it intends to increase those hedges.

Spyglass certainly should be able to do more on the gas side, considering the recent surge in spot prices.

Roger: It’s hard to take anything for granted in a wild and wooly business like this, but I would agree with that assessment. There are also no debt maturities until April 2015.

My view is one of the big reasons Spyglass is still so cheap is that several big investors had to be coaxed into supporting this deal, and I don’t think everyone wound up pleased by the result.

There’s also the fact that this merger was delayed past the initial projected close, which caused Spyglass to delay a fair chunk of its capital spending program until after the spring breakup season.

It made up for this in part by realizing an additional CAD1 million in monthly savings by adjusting its initial dividend lower, which it will use for capital spending as well as debt reduction. And the narrowed Canadian crude oil differentials with higher natural gas prices will definitely help results.

But the impact of the delayed consummation will be something to watch as the company releases numbers later this year.

David: I see management’s targeting a payout ratio of 25 to 30 percent of cash flow, or 90 to 100 percent including capital spending.

Do you think that will be possible in the first or second quarters, or is that something to expect only later in the year?

Roger: Honestly, I’d be surprised if they realized that in the first quarter on a pro forma basis given the delays closing the deal, and the second quarter will be affected by the breakup as it always is.

But again, the pricing is going to be a plus for the first time in a great while, and this is a company with low-decline wells, which can make for positive surprises.

David: Spyglass is kind of a throwback to the kind of producers you used to favor. That is companies that balanced production between oil, gas liquids and natural gas.

Roger: Well, it is at this point, as 49 percent of production at close was liquids. It does look like they’re weighting the future toward liquids, but I think it’d be in good shape based on reserves to adjust if gas really does prove stronger.

What really looks good here is the projection for 2014, with 18,000 barrels of oil equivalent per day output at 55 percent liquids and a capital budget 25 percent higher than this year’s. That’s just based on making more money by raising production and locking in prices for it going forward.

And if it succeeds Spyglass will be paying dividends and drilling more while taking a huge bite out of debt before that April 2015 maturity.

Management is forecasting a total payout ratio–CAPEX plus dividends–of just 80 to 85 percent in 2014 and a drop in the net debt-to-cash flow ratio to 1.7-to-1 from a current 2.1-to-1.

If it gets there this stock is going to go a lot higher–in addition to paying a rich dividend.

David: Sounds like a good combination.

Bay Street, however, is noticeably bearish, with one “buy” against four “holds” and two “sells.” And the only opinion change since the close was a cut to essentially “sell” by EVA Dimensions.

Is that a concern?

Roger: It will be more of one if there’s not some positive movement going forward, particularly when earnings are announced on or about May 8.

The prevailing mood seems to be summed up in the GMP Capital Inc (TSX: GMP, OTC: GMPXF) report rating the stock a “new hold.”

I really think most people are waiting to see how this company fits together and whether it can deliver on its promised synergies from increased scale. And, frankly, there’s a lot we don’t know at this point.

I am encouraged by the 11 percent boost in insiders’ holdings the past six months though. The people on the ground are putting their money where their mouths are.

David: The stock is trading around CAD2 right now, or below USD2 at current exchange rates. Should we put in a buy target of USD2.25?

Roger: At anything around USD2, you’re getting this stock at its components’ lowest prices since last June and more than 75 percent off the spring 2011 high.

It’s hard not to see upside from here, unless this company really does go belly-up. I think the evidence says they won’t. But, again, these are high-stakes bets, and no one should overload on any of them.

David: Is it safe to say this is our riskiest Big Yield Hunting pick?

Roger: That’s definitely a “yes” compared to the lineup we talked about earlier. Invest accordingly.

Also, market capitalization here is CAD261 million currently. That should be enough for anyone to get in, but smaller stocks often are more volatile than large ones.

• November 18, 2011: BreitBurn Energy Partners LP (NSDQ: BBEP)–Buy < USD20
• April 20, 2012: QR Energy LP (NYSE: QRE)–Buy < USD21
• August 24, 2012: Natural Resource Partners LP (NYSE: NRP)–Buy < USD22
• October 19, 2012: Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF)–Buy < USD0.50
• November 16, 2012: Cushing MLP Total Return Fund (NYSE: SRV)–SELL
• December 20, 2012: Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–Buy < USD15
• January 17, 2013: PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–Buy < USD10
• February 22, 2013: Windstream Corp (NYSE: WIN)–Buy < USD11
• March 22, 2013: LRR Energy LP (NYSE: LRE)–Buy < USD18
• April 19, 2013: Spyglass Resources Corp (TSX: SGL, OTC: PACED)–Buy < USD2.25

• August 19, 2010: New Flyer Industries (TSX: NFI-U, OTC: NFYIF)–SELL (06/16/11)
• September 16, 2010: Avenex Energy Corp (TSX: AVF, OTC: AVNDF)–SELL (06/22/12)
• October 22, 2010: Otelco (NYSE: OTT)–SELL (09/21/12)
• November 18, 2010: Telstra Corp Ltd (Australia: TLS, OTC: TLSYY)–SELL (06/16/11)
• January 20, 2011: Cellcom Israel Ltd (Israel: CEL, NYSE: CEL)–SELL (08/18/11)
• February 22, 2011: DUET Group (Australia: DUE, OTC: DUETF)–SELL (08/18/11)
• March 17, 2011: Chorus Aviation Inc (TSX: CHR/A, OTC: CHRVF)–SELL (12/16/11)
• May 19, 2011: The DATA Group Income Fund (TSX: DGI-U, OTC: DGPIF)–SELL (03/23/12)
• June 16, 2011: FP Newspapers Inc (TSX: FP, OTC: FPNUF)–SELL (12/16/11)
• August 31, 2011: Zargon Oil & Gas Ltd (TSX: ZAR, OTC: ZARFF)–SELL (12/16/11)
• September 15, 2011: Alaska Communications (NSDQ: ALSK)–SELL (12/16/11)
• October 21, 2011: PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–SELL (09/21/12)
• December 16, 2011: Telefonica SA (NYSE: TEF)–SELL (09/21/12)
• January 23, 2012: Inergy LP (NYSE: NRGY)–SELL (06/22/12)
• February 16, 2012: Arrium Ltd (ASX: ARI, OTC: ARRMF)–SELL (09/21/12)
• March 23, 2012: Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–SELL (06/22/12)
• April 21, 2011: Superior Plus Corp (TSX: SPB, OTC: SUUIF)–SELL (11/16/12)
• July 22, 2011: France Telecom (France: FTE, NYSE: FTE)–SELL (11/16/12)
• June 22, 2012: Data Group Inc (TSX: DGI, OTC: DGPIF)–SELL (11/16/12)
• July 20, 2012: CSR Ltd (ASX: CSR, OTC: CSRLF)–SELL (11/16/12)
• December 16, 2010: Capital Products Partners LP (NSDQ: CPLP)–SELL (03/22/13)
• May 17, 2012: Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF)–SELL (03/22/13)
• September 21, 2012: Rhino Resource Partners LP (NYSE: RNO)–SELL (03/22/13)
• November 16, 2012: Cushing MLP Total Return Fund (NYSE: SRV)–SELL (03/22/13)