A Vista of Value

By David Dittman • December 20, 2012

What to Buy: Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)

Why Now: Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) is off 45 percent from its Jan. 3, 2012, high of CAD26.77. The stock is currently yielding 10.2 percent, pricing in a dividend cut that doesn’t seem likely to happen.

Bonavista is leveraged to natural gas, with a third-quarter mix of 60 percent gas, 40 percent oil and natural gas liquids (NGLs). Although the short-term outlook is clearly colored gray due to the virtual depression for natural gas over the last four and a half years, Bonavista has a solid set of development projects stacked 10 years deep that ensures production growth for the long term.

A flexible approach to spending on these projects will allow Bonavista to adequately boost output in the near term while holding fire for a time when natural gas economics improve.

Management confirmed the CAD0.12 payout for January 2013, though it is company practice to review the dividend policy on a monthly basis. This process is particularly fraught these days given global economic certainty and the concomitant impact on commodity prices.

During 2012 Bonavista held its dividend steady by cutting its capital expenditure budget, expanding the number of shareholders participating in its dividend reinvestment plan and selling non-core assets to generate cash. Management remains concerned about the persistently low natural gas price and more recent declines for NGLs and oil prices.

Bonavista has been paying CAD0.12 per share per month since February 2011, and management has repeatedly expressed confidence in its ability to maintain this rate.

Bonavista Energy Corp is a buy under USD15.

The Story

Natural gas prices have experienced a significant downturn since 2008 but have actually posted a strong rally in the second half of 2012, auguring solid financial results for producers into 2013.

Prices for crude oil and natural gas liquids (NGLs), however, have languished with continuing and growing concerns about global growth, sentiment waxing and waning with each update on, for example, “fiscal cliff’ negotiations in the US or the stimulative intentions of China’s new group of leaders.

What this volatile environment does do is open up opportunities to buy solid oil and gas producers with the proven ability to control costs and manage their assets for the long term.

Roger: We did some serious housecleaning in last month’s issue, closing out our positions in Superior Plus Corp (TSX: SPB, OTC: SUUIF), France Telecom SA (France: FTE, NYSE: FTE), Data Group Inc (TSX: DGI, OTC: DGPIF) and CSR Ltd (ASX: CSR, OTC: CSRLF).

We booked losses on the first three but did well with CSR, which has actually continued to push higher on the Australian Securities Exchange. But I am happy we were able to post about a 40 percent gain on that recommendation.

Before we dive into this month’s pic let’s take a look at our current Open Trades.

David: Sure. Let’s start with our oldest position first.

We’ve been in Capital Product Partners LP (NSDQ: CPLP) for two years now, since Dec. 16, 2010. It’s generated a total return of negative 11.7 percent. And it’s only this good because of consistent distributions: The unit price is off 29.7 percent.

After a solid run to USD11.32 in May 2011 the stock bottomed, quickly, at USD4.89 on a closing basis on Aug. 8, 2011. The stock has trended higher but has certainly been bound by rising pessimism about the global economic situation.

The tanker operator has several ships coming off charter in 2013 and 2014, but its sponsor has already said it would re-up at least two if third parties don’t engage them. And management has reaffirmed the current dividend level.

I think we should stick with this one; we’ve come this far, and I think we may see a run that helps us get to breakeven in early 2013.

Roger: I’m with you on this one. The support of a strong sponsor–particularly as it relates to distribution-supporting asset drop-downs–is critical for master limited partnerships, and Capital Product has that in Capital Maritime & Trading Corp.

BreitBurn Energy Partners LP (NSDQ: BBEP) is trading above our entry price and is still dishing out a reliable distribution. The yield is still near 10 percent because of recent increases. We’re not in the business of establishing long-term holdings in this particular service, but I’m for sticking with this one. And BreitBurn has a nice, balanced production mix and continues to grow output at a steady pace.

David: I agree. I’m a big fan of letting winners run.

I’m a little mystified by the market’s pessimism about QR Energy LP (NYSE: QRE). It looks like the most recent leg down is all about a new offering of units, which always seems to hurt unit prices in the short term due to dilution fears.

But QR has basically hit all the guideposts it laid out at the time of its initial public offering (IPO) in December 2010. Third-quarter results were a little soft, but this oil and gas producer continues to add productive assets. And the distribution coverage ratio was better than 1.0-to-1.0.

Roger: QR also hedges its output aggressively, which provides another layer of distribution support. I think we could be seeing some additional skepticism due to questions about the taxation of master limited partnerships (MLP) come 2013 and “comprehensive tax reform” in the US.

Who knows, but the MLP sector as a whole has lagged this late fourth-quarter/winter rally.

David: I think the selling on this one is overdone, and I think it’s worth holding onto as a play on rebounding sentiment, stronger-than-expected 2013 global growth and better commodities prices.

Roger: Agreed.

What’s the word on our “bet on betting itself,” Australia-based Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF)?

David: Well, this one has popped again and is currently above our buy-under target of USD3.15. The stock certainly participated in the “Christmas Rally” Down Under, bouncing off a near-term closing low of AUD2.63 on Nov. 19–which actually matched its 12-month low–to AUD3.01 as of Dec. 20 on the Australian Securities Exchange.

Consumer sentiment in Australia has been weakening, but the folks Down Under continue to place bets. There are some headwinds, including state gaming license renewals under less favorable terms and coming renewals that will cost money.

But this is another one with what appears to be strong momentum at its back. I’ll be watching closely for a reversal–particularly in light of the fact that we held on as the stock hit AUD3.33 (roughly USD3.52) in August and then cratered to that November low.

Roger: Our back-to-back coal plays–Natural Resource Partners LP (NYSE: NRP) for August and Rhino Resource Partners LP (NYSE: RNO) for September–both hit 12-month lows on Nov. 15, though they’ve both rebounded, however slightly, in recent days.

David: Look, “coal” is a four-letter word, literally as well as, it seems, in the figurative, foul-mouthed sense. Nobody likes it, but everybody uses it.

As you noted last month, both of them covered distributions comfortably in the third quarter. And both of them reported solid operating results, with Natural Resource’s production from its coal lands up 11 percent.

Rhino’s coal sales, meanwhile, were up 8.3 percent. And cash flow was three times the distribution.

No doubt many investors fear what a second Obama administration will do to coal production in the US. But rational minds will see a. that coal’s relative decline in the US has more to do with cheap gas, and b. that the black mineral will remain a key component in the power-generation equation, in the US and, particularly, in Asia.

The bottom line is these two still look like compelling values at these levels, Natural Resource Partners yielding 12.5 percent, Rhino Resource Partners 13.6 percent.

As for the Australia-based dividend-paying copper producer we recommended in October, Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF), upside from here is basically a function of China continuing to show positive momentum.

The company has no debt, and management reported a significant upgrade to its reserve estimate for its key Mt. Gordon mine, of two high-grade mines, along with Nifty, that it operates.

For the first half of fiscal 2013 ore mined was up a combined 37 percent, ore processed was up 33 percent and copper production increased by 25 percent.

Aditya Birla pays even less frequently than the typical Australia-based company’s periodicity of two times a year, and it omitted a dividend entirely in 2009 and 2010. But based on the May 2012 payment of AUD0.05 per share it’s yielding 10.9 percent.

And as of this writing it’s below our buy-under target of USD0.50 per share. I think it’s a solid way for aggressive investors to play a rebound in China and in copper prices.

Roger: I’m on board with that.

Our November pick, Cushing MLP Total Return Fund (NYSE: SRV), owns a diversified basket of mostly energy midstream MLPs. It’s a closed-end fund, which means recommending it is a departure from my usual practice of sticking to individual stocks.

But this fund pays its distribution from income from the MLPs it holds, and it’s come well down from a premium of 25 percent to net asset value. On Nov. 29 the fund declared another quarterly distribution of USD0.225 per unit, which will be paid Dec. 21.

I’m still comfortable with the thesis from last month, that the distribution will hold and that the fund’s price will head back toward USD10 over the next 12 months.

David: All the negative-sentiment factors impacting our individual MLP positions are clearly weighing on this one, too. I like that about 55 percent of its holdings are pipeline MLPs and their fee-generating assets. I also like the potential upside its oil and gas production exposure provides.

Speaking of oil and gas production, how about Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) showing up on our list of candidates this month?

Roger: Although it’s not a bright-line rule, we do focus on stocks with double-digit yields in Big Yield Hunting. And, yes, it is quite a pleasant opportunity to be able to recommend what is a high-quality company at these levels.

David: I want to start with a curiosity about analysts’ views on Bonavista, at least as far as Bloomberg’s aggregation of opinion is concerned.

Based on its standardization of Bay Street analyst-speak, Bloomberg counts five “buy” recommendations among those investment houses that cover the stock, 12 “holds” and two “sells.” That’s a decidedly tepid consensus, with an average score of 3.32, with a “buy” worth five points, a “hold” worth three and a “sell” one.

Here’s what intrigues me: The average 12-month price target among the 17 analysts that provide such a figure is CAD18.85. So the implied upside–not even considering Bonavista’s monthly distribution of CAD0.12 per share–is 33.2 percent as of midday on Dec. 20.

And another thing: Scotia Capital “downgraded” the stock to “sector perform,” which translates to “hold” according to Bloomberg’s system, from “sector outperform,” which means “buy.” It also reduced its 12-month target to CAD18.50 from CAD20.

But even at the reduced target upside from here is better than 30 percent.

Roger: Of course, analyst opinion, even in the aggregate, is far from dispositive. We use what they say as part of a larger analysis, but nobody should take what they say to the bank. As you’ve noted repeatedly in the Bay Street Beat feature of Canadian Edge, they’re possessed by a group-think that prevents any one of them from really stepping out from the consensus.

And at the end of the day what really matters–even when it comes to hunting down oversold, high-yielding picks–is what operating and financial numbers at the company level say.

So, what do Bonavista’s numbers say?

David: Let’s start with the fact the third-quarter payout ratio was a very manageable 75 percent of funds from operations. That’s a good number.

Less good: Third-quarter production was down 9 percent to 65,464 barrels of oil equivalent per day due to asset sales, reduced recoveries from third-party facilities and natural gas reductions. Natural gas and oil production both decreased 11 percent, while NGLs was basically flat.

And production revenue was down 29 percent to CAD188.6 million due to lower commodity prices and lower production volumes. Third-quarter natural gas prices were down 38 percent, crude oil was 3 percent lower and NGLs were off 26 percent.

Roger: The only thing that worries me about that is production going lower. But that definitely appears to be a matter of choice in this case, as a response to lower energy prices.

They definitely have a lot in the ground. And the important thing is they have the wherewithal to get it out when prices do become more favorable.

It’s also encouraging that the third-quarter numbers were all in line with guidance. One thing–actually, one thing among many–Bonavista does well is understand its properties and their potential. When they sign contracts and start work on an asset they have a good idea of what’s going to come out.

David: Back to your point about always wanting energy producers to be able to ramp up output, Bonavista’s drilling results during the period were solid, particularly at its key Hoadley liquids-rich natural gas play. Results from its West Central Cardium light oil prospect were also positive, despite mechanical issues at two wells.

Cash costs were down 3 percent compared to a year ago and are up just 1 percent for the first nine months of 2012 compared to the same period of 2011.

CAPEX guidance was boosted to CAD400 million to CAD450 million, an increase in exploration and development spending of approximately 13 percent over 2012.

And management expects to produce 72,500 to 74,500 barrels of oil equivalent per day (boe/d) in 2013. For comparison’s sake 2011 production was 69,300 boe/d, and for the first nine months of 2012 it was 68,400. Management expects average 2012 production volumes of approximately 69,600 boe/d.

Roger: The flexibility is also a really nice advantage, particularly when it comes to maintaining a dividend. Though it’s budgeted CAD400 million to CAD450 million for CAPEX for 2013, this could change with commodity prices and the corresponding impact on its growth-and-income model.

The balance sheet here is also an advantage. Current debt of approximately CAD950 million is well within the company’s limit of CAD1.55 billion. Bonavista has traditionally carried a higher debt burden than its peers, so a debt-to-assets ratio of 28 percent is little cause for worry.

I also like the fact that the next big maturity isn’t until Sept. 10, 2016, when its CAD1 billion credit agreement is up for renewal. They could wait out a tightening of credit markets if we see one in 2013. And there’s only CAD216.62 million drawn at this point in any case, so there’s plenty of room to finance growth if they wanted to.

David: I think we should say a couple of words about Bonavista’s dividend history. It converted from income trust to corporation in January 2011, when it reduced its monthly payout from CAD0.16. The payout reached a trust-era peak of CAD0.33 per in October 2006 before management cut to CAD0.30 in November 2006.

It maintained this level until February 2009, by which time natural gas had fallen from above USD13.30 in July 2008 to below USD4.30 and Bonavista reduced its distribution to CAD0.20. From there it went to CAD0.16 in April 2009 and then to CAD0.12 upon conversion in February 2011.

Roger: That may seem like a lot of variation to our readers. But considering where energy prices have been the past few years, it’s actually a lot more stability than the norm.

And let’s not forget that Bonavista is a producer of energy first and last. Earnings are affected by drops in energy prices. But they also benefit when prices firm. I’m not hugely optimistic for a big move in natural gas. But expectations for energy prices are pretty low right now on Bay Street and Wall Street and won’t be hard to beat.

We could easily see Bonavista rally hard on that basis, even if oil and gas just stay where they are right now. And it’s hard to see NGLs prices–which are Bonavista’s forte–performing much worse than they did last year.

David: I agree. And taking risks for big gains and high yields are what we do here at Big Yield Hunting. I say let’s recommend Bonavista a buy up to USD15. That will give anyone who buys it a monthly yield of 10 percent that management has basically affirmed for 2013.

Roger: There are no sure bets in this market, particularly when you’re purposefully taking risks. But this looks like a good bet that could pay off richly this year. Let’s do it.

David: OK, then.

Bonavista Energy Corp is a buy under USD15 for aggressive investors playing with speculative capital who understand the downside as well as the upside risks of putting money to work on high-dividend-paying oil and gas producers.

  • December 16, 2010: Capital Product Partners LP (NSDQ: CPLP)–Buy < USD9
  • November 18, 2011: BreitBurn Energy Partners LP (NSDQ: BBEP)–Buy < USD20
  • April 20, 2012: QR Energy LP (NYSE: QRE)–Buy < USD21
  • May 17, 2012: Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF, ADR: TACBY)–Buy < USD3.15
  • June 22, 2012: Data Group Inc (TSX: DGI, OTC: DGPIF)–SELL
  • July 20, 2012: CSR Ltd (ASX: CSR, OTC: CSRLF)–SELL
  • August 24, 2012: Natural Resource Partners LP (NYSE: NRP)–Buy < USD22
  • September 21, 2012: Rhino Resource Partners LP (NYSE: RNO)–Buy < USD16
  • October 19, 2012: Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF)–Buy < USD0.50
  • November 16, 2012: Cushing MLP Total Return Fund (NYSE: SRV)–Buy < USD8
  • December 20, 2012: Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–Buy < USD15
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