A successful International oil and gas explorer focused in Egypt.
This week, we revisit an issuer that continues to perform well, even in the midst of adversity. TransGlobe Energy’s very short (2 year) convertible Canadian-dollar bond is currently indicating over 14% yields. This oil producer, with its main operations in Egypt, has continued to impress us with its high cash levels (which exceed its debt), its commitment to pay quarterly dividends to its shareholders (currently $0.05/share), and its continued profitability, even as oil prices have continued to decline. The company’s outstanding USD $83 million debt is dwarfed by its $140 million in cash plus the $500 million value of its hard assets (property and equipment). For the income investor, this presents an extremely low default risk. TransGlobe continues to receive increased payments from Egypt’s government, increase cash flow and reduce their large receivable balance. Its recently released 2015 guidance is conservative, allowing the company to remain profitable, but also allowing for capital expenditure expansion if and when oil prices begin to rise.
Transglobe recently entered into a joint marketing agreement with EGPC (Egypt’s state-run oil company) that will allow them to directly contract oil shipments with international buyers. This new marketing agreement will eventually eliminate issues regarding receivables for oil sales. In addition, the convertibility feature (explained further in this review) of this bond presents additional opportunity to increase investor return. TransGlobe’s stock is currently trading at the low end of its 52-week range, and significantly lower than the stock’s high point in 2010. However, as oil prices recover, this low-cost producer could see its stock price appreciate as well. For these reasons, we have marked these discounted Loonie bonds from Transglobe Energy for an overweight position within our high yield FX2 and FX3 global portfolio strategies.
An Update on the Issuer
We last reviewed TransGlobe in September 2014. One of the most notable recent developments is TransGlobe’s new ability to market its own oil, resulting in more timely cash payments for product sold. In December 2014, the company entered into a new joint marketing agreement with EGPC. The new agreement will allow TransGlobe to directly contract oil shipments with international buyers. The first oil shipments under this agreement are scheduled for late January and in April 2015.
TransGlobe is also making progress with EGPC to reduce its excessive accounts receivable balance with the state-run oil company. In order show goodwill toward the international investment community, the Egyptian government has recently stated its intent to pay all outstanding amounts due to foreign oil companies (USD $4.9 billion) by May 2015. In 2013, TransGlobe was able to collect USD $72.7 million from EGPC (the state-owned oil company). Contrast that amount with the USD $233.5 million TransGlobe was able to collect in 2014, and it is clear that Egypt intends to make good on its promise.
The company had to revise its 2014 production guidance due to prolonged pump issues at its West Gharib facility, decreasing production between 800-1000 Bopd. Production continued to be impacted during Q4 2014. However, the Company received replacement PCP pumps from a new supplier in late December. When installed, the fully functional pumps will help recover production levels and streamline production costs. It is important to point out that even with the decreased production in the last half of 2014, TransGlobe remained profitable.
TransGlobe’s crude oil reserves are reviewed annually at the conclusion of the company’s fiscal year. TransGlobe’s reserves have been independently evaluated by a third-party engineering firm, DeGolyer and MacNaughton. As of December 31, 2014, TransGlobe had a total of 33.5 million barrels of Proved plus Probable reserves and 43.3 million barrels of Proved plus Probable plus Possible reserves.
Falling Oil Prices and PSC’s
Since mid-2014, oil prices have fallen dramatically. The latest prices for Benchmark Brent oil was just over USD $55 per barrel. This most recent price reflects a per barrel price at almost half of the cost of 12 months ago, when the price per barrel was around USD $105. This dramatic decrease in the price of oil is principally due to a disproportionate amount of oil being produced. With the new found shale reserves in the US, the supply of oil has increased rapidly. Excess supply has driven prices even lower. For many of the North American shale oil producers, the break-even price for oil production is around USD $60 per barrel. In contrast TransGlobe’s break-even price is $27 per barrel, which still allows for a level of profit, even at oil’s current reduced prices.
There is another favorable feature of TransGlobe’s business in the current environment of falling oil prices – their Production Sharing Contracts (PSC’s) with the Egyptian government. (We discussed PSC’s in our previous TransGlobe review). All of the Company’s production is priced based on Dated Brent and shared with the respective governments through PSCs. When the price of oil increases, it takes fewer barrels to recover costs (cost recovery barrels) which are assigned 100% to the Company. Conversely, when oil prices decline it takes more barrels to recover costs (cost recovery barrels) which are assigned 100% to the Company. As illustrated here, the PSC has an allotment for “recovery oil”. This allows TransGlobe to recover its costs before it shares its revenues. In doing so, the PSC acts as a shock absorber when oil prices are low.
We like companies with excellent ratios and strong balance sheets
TransGlobe has an exceptional interest coverage ratio. For the nine months ending September 30, 2014, the company had interest expense of USD $6.226 million, while EBIT for the same time period was USD $113.915 million, resulting in a very healthy interest coverage ratio of greater than 18 to one.
At the conclusion of 2014, TransGlobe’s had a cash balance of USD $140 million, exceeding its long-term debt of $83 million, primarily from this bond issue. In our time of actively following TransGlobe, it has always maintained a cash balance greater than its debt. This large cash balance, along with the fact that TransGlobe finances all of its capital expenditures with cash generated from its operating activities, puts the company in a solid position to weather the current storm in the oil markets. The company also has a large asset base in its property and equipment, which was valued at USD $504.7 million as of September 30, 2014.
We like companies that are profitable
Funds flow from operations for the nine months ending September 30, 2014 was USD $104.5 million. As of the writing of this review, Q4 2014 financials have not been released. However, the company has released 2015 guidance. It is conservatively forecasting funds flow from operations for Q1 2015 to be $1.0 million (~$0.01 per share) based on an average Brent oil price of $50/Bbl using production guidance of 14,000 Bopd.
The current yield of 14% is exceptional. These Canadian bonds represent a welcomed opportunity for increased yields given the risks we have identified. An unusual feature of this bond issue is the option to convert (prior to maturity) these debentures into common shares at the conversion price of $15.10 (Canadian dollars) per common share (current share price is $3.77 Canadian dollars). With the political situation in Egypt stabilizing, we think any significant increases in production could easily restore equity markets’ confidence in this company to boost its share price back to the more respectable levels of past trades.
The default risk is TransGlobe’s ability to perform. TransGlobe has positioned itself well to weather the current low oil price environment. They have low break-even costs, their cash levels exceed their debt, and they are consistently receiving increased payments from EGPC.
Transglobe’s singular focus on oil is also a risk. Falling oil prices have certainly cut into the company’s profits. However, the Production Sharing Contracts mean that the Egyptian government shares in the risk of decreasing oil prices
Perhaps the most difficult risk to quantify is the geopolitical risk. Egypt is making strides to endear itself to the international community. In late 2014, it paid out USD $2.1 billion in receivables to foreign oil companies. It is also hosting an international economic summit in March 2015. The conference will focus on developing various sectors of the economy, as well as energy, healthcare and education. On a separate note, TransGlobe has recently written down its Yemen asset values to zero, and relinquished its interests in two of its operating blocks in Yemen. The company will continue its focus on growing its business within Egypt.
Since these bonds are denominated in Canadian dollars, bondholders would be subject to risks of the Canadian economy and the US / Canadian dollar exchange rate.
These bonds carry similar risks to other convertible debentures we have previously reviewed on our Bond-Yields.com blog, including the 5.6% Tricon Capital convertibles, the 9% Lake Shore Gold convertibles, and the 7.5% Canwel Building Materials convertibles.
Summary and Conclusion
TransGlobe is in a solid position to endure the current low price oil environment. It has a strong balance sheet as well as an extremely healthy interest coverage ratio. Its newly added ability to market its oil directly to international buyers means less delay in receiving revenue. In addition, there is a real possibility of EGPC coming current with its account receivable balance, which represents an additional USD $120 million cash to the company. The financial markets continue to be wary of investing in a company so heavily concentrated in Egypt, but we think TransGlobe is very well managed, as it has weathered the geopolitical turmoil of the past and continues to thrive. Therefore, these Canadian-dollar based bonds, priced aobut 87 and indicating an outstanding yield that is over 14%, present a welcomed opportunity for investors seeking higher yields with lower default risks, and we are adding them to our Fixed-Income2.com and Fixed-Income3.com global portfolios.
Issuer: Transglobe Energy Corporation
Ticker: TGL (TSX Exchange) / TGA (NASDAQ)
Stock Price: 3.77 (CAD) / 3.02 (USD)
Bond Coupon: 6.00%
Conversion Option Price: $15.10 CAD
Price: 86.0 (3/3/2015)
Yield to Maturity: ~14.06%
Disclosure: Durig Capital and certain clients may have positions in TransGlobe Energy bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this Transglobe bond, call our fixed income specialist at 971-327-8847
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