Investing

Whenever I have a question about natural resource stocks, I call Sam Parks. Sam’s research is impeccable, he has the experience necessary to make good judgements, and he is a man of integrity..

Sam entered the brokerage business on January 2, 1959, working for a little firm in Spokane that handled mining stocks. Two brokers took him under their wing and taught him why gold (then fixed at $35 an ounce) was valuable.

After working with gold stocks for years, in 1990 Sam took off a year and a half to study oil stocks, and later, natural gas stocks. Sam Parks works with National Securities, 1001 Fourth Avenue # 2200, Seattle, Washington 98154. You can call his office at (800) 426-9993 or (206) 622-7200.

I last interviewed Sam in the 3/00 Moneychanger. At that time we talked about several stocks. Before we proceed to Sam’s new article about gas stocks, I’d like to update you on those stocks we talked about last March.

Maxx Petroleum, MXP.Toronto was then trading about C$4.00. In October it hit a high of C$6.80, in January backed off to C$4, and now is trading around C$4.60.

Canadian 88, EEE.Toronto last march was trading at C$1.63. By August it had risen to C$4.00, just after Sam recommended selling it. Late last year it backed off to C$3, and now at C$4.50 will soon be taken over.

Centurion, CUX.Toronto was trading at C$0.49. In August 2000 it peeked over C$1.00, and today stands at C$0.75. Sam has recommended keeping the stock and is in fact still buying more.

I couldn’t resist asking Sam for his favourite three gold stocks, given that the gold mining sector is today so depressed. Here were his picks:

Aurizon, AUR.Toronto currently at C$0.61 (US$0.41)

Cumberland, CBD.Toronto currently at C$0.68 (US$0.46), and

Minefinders, MFL.Toronto currently at C$0.92 (US$0.62).

All three of these companies have excellent deposits of two to three million ounces. These have been drilled off and proven out, but not yet developed, i.e., no mill or operations. All three are selling for less than $5/ounce in the ground. All, too, are marginally economic, that is, they are not in production and won’t be produce until the price of gold rises. They are pure deposit plays, waiting for gold to rise, a way to buy gold in the ground very cheaply. They offer very high leverage to the gold price (not on their balance sheets – none are in debt). At present prices none of these deposits is economical, that is, it costs more to mine the gold than you can sell it for. However, once gold crosses their cost of production, the value of the deposits will rise astronomically. Furthermore, these are all reputable companies that are not likely to evaporate.

Add to that the plight of the majors in the gold mining industry. All are interested in these three little companies because they have 2-4 million ounce deposits surrounded by a land position promising further discoveries. Five years ago the majors wouldn’t have been interested in these little companies at all, but they are very intriguing for them today. Why? The majors can’t find any new deposits on their own. That makes all three candidates for some major to buy out. When that happens, look for their stocks to rise anywhere from five to ten times.

However, everything depends on a gold move. Aurizon’s deposit needs a gold price of $280 to break even, Cumberland’s needs $325, and Minefinders’ needs gold over $300. Without gold rising to those levels, they’ll keep on doing nothing. I concur with Sam; these three gold stocks are a very attractive speculation.

And now Sam’s latest thoughts on natural gas stocks.

BACKYARD PRODUCERS

A revealing article appeared on page A4 of Wednesday’s (1/31/01) Wall Street Journal. Staff reporter Chip Cummins reports that about 20 large natural gas producers, accounting for close to 40% of domestic production, have reported fourth-quarter results. The 20 companies (presumably majors because they report earlier) reported that production was actually down 3.7% from Q4 ’99 to Q4 ’00. Using the same time frames, production for our three favourite Canadian gas stocks BelAir Energy (BEC, US $2.11), BXL Energy (US $1.61), and Player Petroleum (PYP, US $11.50) rose an average of 74%. (Our three stocks have not reported their Q4 numbers yet, so these numbers are mine. But they should be close.)

It is well known that the opportunity for growth lies with the smaller producers. But, these smaller producers are considered to be riskier. While that is true, we must consider the significant cash flow and earnings that these small companies are making. Table #1 presents the increase in production for the fourth quarter of 2000 over the same quarter in 1999, the share price increases for the past 12 months, and the trailing 12-month PE ratio.

Table #1 Prod Increase Share Price PE Ratio

BelAir Energy +45% +171 % 9.8 x

BXL Energy +90% +187 % 9.6 x

Player Petroleum +88% +181 % 6.2 x

Table # 2 shows the production increases from 1999 to 2000 and our forecast for 2001. Note that the percentage increase forecasted for 2001 is smaller than the increase from 1999 to 2000. Why? Mostly because their base of production increased. These companies are larger now and not expected to grow quite as fast. Keep in mind that even though these companies are 70% to 80% natural gas, the numbers below are stated in barrels of oil equivalent per day (boed). 10 million cubic feet of gas equals 1000 barrels of oil.
 
 

Table #2 1999 2000E 2001 Forecast

BelAir Energy961 1,300 2,300 + 77%

BXL Energy732 1,535 2,575 + 68%

Player Petroleum 1,329 2,700 3,960 + 47%
 
 

We call these companies "back yard" producers – meaning that their operations are close to home rather than "frontier" companies seeking higher risk / higher reward plays outside their own backyards. All three companies have operations within a few hours drive of their corporate offices. Backyard companies are not trying to hit home runs; they are endeavoring to conservatively and methodically build their oil and gas production and reserves.

A good gas stock, in my opinion, has several characteristics:

Management that is highly regarded by its industry peers and the financial community as good oil and gas finders. Such a reputation will nearly always come from their successes at previous companies. Management should have meaningful stock positions in the company.

A highly focused corporate strategy.

A large and high quality undeveloped land position containing a mix of mostly low risk development plays with some higher risk high impact opportunities. Not all junior Canadian and U.S. companies have such growth prospects. In times of strong commodity pricing, good land is difficult to find and can be expensive to acquire.

Low debt – less than 1.5 times annual cash flow.

Sufficient capital to execute its strategies. Capital budgets can be financed from three sources – cash flow, debt, and equity. We prefer companies that can finance at least 80% of their capital budget from cash flow with no more than 20% from debt.

A production and reserve mix that favors gas.

Daily production from 10 to 50 million cubic feet. (1000 to 5000 boed.)

FRONTIER STOCKS

Finally, Centurion Energy (US$0.50) and Tikal Resources (US$.04) are two examples of "frontier" stocks. Centurion’s frontier is in Egypt and Tunisia, while Tikal’s is in England and northeast British Columbia Both of these companies are riskier , but they offer opportunities for larger gains.

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