When my students are stuck for ideas on how to conceptualise what they’ve learnt, I tell them straight: “puke out all of your ideas onto the page, no matter how far fetched or ‘weird’ you think your thoughts are. Just write it all down until you can’t think of anything else.”
Almost immediately, students begin to think about organising their own ideas into a coherent format so that they get to understand what they’ve learnt and why they are conceptualising what they’ve learnt.
Mind maps, tabled information, even mini film scripts. It’s amazing to me how young minds at such a crucial stage of their development know instinctively how to get the best from what they’ve learnt to bring their understanding of a subject to the next level.
It’s the same with stocks.
The only way for me to really get to know a stock is to either:
- Buy some and see how it behaves (I don’t think so) or
- Conduct some research to see how it has behaved in the long term past
Today’s post sees me ‘puking out’ my thoughts on Regal Petroleum Plc (RPT) listed in London which is currently priced at 28% of it’s tangible book value.
I’ve noticed of late that my research process does not follow a set pattern and instead follows a ‘see where I end up (puking)’ approach often leading to many dead ends which in themselves can often reveal a lot about a stock.
There is more (way more) desk research than can actually fit into a blog post and keep it to a reasonable length but the results of what I’ve discovered about Regal Petroleum and what I ended up puking out are presented below.
Regal Petroleum Plc (LSE:RPT) is an oil and gas company listed on the Alternative Investment Market (AIM) that is developing two gas fields in Eastern Ukraine. Since July 2004, Regal have had a 100% interest on two production licences and has been developing them ever since.
The latest operational update from Regal is for the period 1 January 2013 to 30 June 2013 includes 199,984 m³/d of gas and 44 m³/d of condensate. This equates to 1,525 boepd in aggregate (m³/d = cubic metres a day/boepd = barrels of oil equivalent per day) for the period.
- Management advise that possible hydraulic fracturing is being considered at one well (MEX-105) due to the weak gas flow rates they recorded during testing.
- At another well (SV-53) they have developed a fracturing programme which they were considering but now appear committed to implementing.
- At well SV-59 they continue to drill and at GOL-1 management are working towards bringing the well back into production.
- Management are also spending cash on upgrading their gas processing facility to improve efficiency and quality of gas produced.
After the most recent round of testing, Regal had this to say about the value of their assets:
In light of the results from these wells, new geophysical studies are being undertaken, which together with the results of future wells and the well stimulation programme, may cause the Group to consider revising the current field development plan, which in turn may result in a reduction in the carrying value of the Group’s oil and gas development and producing assets in the Ukraine – pg 3, 2013 Interim Results
Let’s dig a little deeper into the assets of Regal Petroleum.
The Balance Sheet (from 2012 Annual Report)
As you can see intangibles are tiny but PPE is a whopping $233,508,000 making up the majority of Regal’s assets. Just what are those assets? Note 16 to the accounts is reproduced below:
Note 16 To The Accounts
So development and production assets (costs) in the Ukraine account for the Regal’s assets. Its funny how development costs end up on the balance sheet but Regal should not be singled out for this since it is a peculiarity among oil and gas companies to account for their costs in this way.
But it does beg the question what has been the historical Return On Equity for Regal?
The more common Return On Capital Employed (ROCE) is useful for companies with high amounts of debt which does not square with Regal since they have hardly any debt although I’ve included ROCE for completeness.
Return On Assets and Return On Capital Employed Over The Last 5 Years
Courtesy of Morningstar.co.uk
Not too good at all and what I’d expect for a stock currently selling for 28% of its tangible book value. At least Regal have managed to post positive returns as against their assets over the last few years.
Of particular interest is an admission that following an independent audit of the gas fields in the Ukraine a revised estimate of 31.6 MMboe (million barrels of oil equivalent) has been applied compared to the previous estimate of 151.3 MMboe (a difference of 80%) which has not resulted in an impairment loss for 2012 because there continues to be ‘headroom’.
Regal define ‘headroom’ as “the difference between the value in use and the carrying value of the asset”.
Things get even more complicated when the calculation of the value in use is based on commodity prices and the use of a discounted cash flow rate in which a 1% increase in the discount rate would not result in an impairment charge but a reduction in the ‘headroom’.
To compound the issue, current licences in the Ukraine expire in 2024 and an extension has not been applied for. You can access the complete Annual Report for 2012 here.
The facts are these:
- Regal have in the past overstated the value of their assets
- Trying to calculate the true value of tangible assets from the accounts is impossible
In order to remain conservative, I’ll apply a two-thirds discount to the value of Regal Petroleum’s PPE as follows:
$299,754,000 (total assets) minus 65,000 (intangibles) minus 66% = $98,897,000 minus $14,636,000 (total liabilities) = $84,261,000 tangible book value.
According to ADVFN, there are currently 318,370,000 shares outstanding which equates to a tangible book value per share of 26¢ a discount of 4% when applying the current exchange rate ($1/£0.62) to the current market price of 15½p or 25¢.
*This revised valuation of Regal will have consequences (a lowering) on rates of return on assets.
Apart from the financial shenanigans outlined above, management more or less have shareholders’ interests aligned with their own:
- Although 2,270,000 options were exercised in 2011 costing $183,000 there were no share options granted to any employees in the last financial year (2012)
- Share options are reported as an expense through the P & L and there are currently no options outstanding
- Management have been honest about the future prospects of Regal and how it will affect shareholders (see below) but opaque when it comes to their assets.
- To reduce costs, management have reduced head count at operational and administrative level
- In calculating earnings, Regal have stated that “the impact of share options is either insignificant or, for the periods for which there was a loss, anti dilutive”.
- In 2008, Return On Capital Employed (ROCE) was -24.42 in 2012 it was 4.44, not stellar, but they have steadily reversed a negative trend.
One thing I like about the management of Regal are their fair and frank assessments of future prospects an example of which I’ve reproduced verbatim here from their last annual report (2012):
Producing gas and condensate reservoirs are generally characterised by declining production rates which vary depending upon reservoir characteristics and other factors. Future production of the Group’s gas and condensate reserves, and therefore the Group’s cash flow and income, are highly dependant on the Group’s success in operating existing producing wells, drilling new production wells and efficiently developing and exploiting any reserves, and finding or acquiring additional reserves.
By Regal’s own admission, operating in emerging markets carries a greater risk than those which are more developed and it has had experience of such risks in the past:
This episode is bizarre since the Ukrainian government is keen to develop it’s own domestic production of gas because it imports the majority of its gas from Russia. Without digging any deeper in respect of this issue one can only conclude that there were political motives behind the suspension.
Also, Regal’s largest shareholder Energees Management Ltd are the principal holding company of Smart Holding Group, owned by Vadim Novinsky a billionaire businessman and Ukrainian politician. Novinsky currently owns 54% of the common stock and one would think that his experience and connections would mitigate any emerging market risk.
Regal Petroleum Company Intrinsic Valuation
- Stated tangible book value: 55p/89¢
- Ultra conservative tangible book value (PPE reduced by 66%): 16p/26¢
- Conservative tangible book value (PPE reduced by 50%): 42p/68¢
A current market value of 15½p/25¢ would equate to a margin of safety of 50% for a more than conservative tangible book value per share of 50¢.
5 Year Price Chart Of Regal Petroleum
Chart from Yahoo! Finance showing multi-year lows
Here’s A List of Tools I Used To Research This Stock
- Yahoo! Finance! – This was used primarily to obtain the price chart for Regal Petroleum. I find that Yahoo! Finance’s charts are accurate, look pretty, can go back decades and you do not need to sign in to use them.
- ADVFN ‘Financial’ Page – ADVFN are awesome and pretty much layout the majority of the information you need on a stock on one page – check out the ‘Financials’ page for Regal Petroleum here.
- ADVFN ‘News’ Page – You’ll need a free account to check this out but again, you can find all the past public announcements including financial information going back years for a stock which is where I spent a lot of time researching Regal Petroleum.
- Regal Petroleum Website – the website is pretty good at directing investors towards the information they seek. For example this page showed me who are Regal’s largest shareholders.
- ADVFN Screener – I use screeners as well as the daily list of 52 week lows to discover undervalued stocks. The actual screener that Regal Petroleum showed up on was the same as this one.
- Morningstar.co.uk – Another great financial website that tabulates financial information in an easy-to-read format. Of particular usefulness is the page Morningstar provide called ‘Financials & Ratios’ which you can view here for Regal Petroleum.
- Google – Doing a ‘Google’ on any company you’re researching is a must because of the way Google is promoting the most recent and the most relevant content towards the top of search results. Using Google led me to find out more about Regal’s largest shareholder.
- Regal Petroleum Annual Reports – There is no way I would have been able to find out the financial shenanigans, emerging market risks or quality of management without consulting the annual reports. They are a must.
Thanks for following my thought processes on this stock.
There is a lot more than can be said about researching undervalued stocks such as comparing a stock with others in its industry to contrast differences in value metrics such as price to cash flow, earnings or tangible book. I also deliberatly left out any discussion about earnings to concentrate on assets but it’s always a good idea to check these things out 🙂
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Image: Cooking with gas
I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours. I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.