Year in review: The Oil and Gas Investments Bulletin portfolio

Dear OGIB Reader,

In 2013, I had to go “out-of-the-box” to make money for me and subscribers. When most investors think junior oil and gas—my main area of investing—they think about the producers.

But I found this sector of the energy complex a tough place to make money in 2014—so I often went elsewhere.

And the place I visited most often was refineries. In late August 2012 I made a big investment in a newly-listed independent refinery in the US (as opposed to “integrated” refineries, like we have in Canada, where they actually produce the oil and refine it—independent refineries just buy their crude) at $19.

As the Brent-WTI spread stayed much wider for much longer than consensus, the trade worked great, and I sold the stock in March 2013 at $32. I was so convinced on this one I put a lot of money into it—and it was my biggest single gain of the year. I’m looking for 50% gain inside a year on every investment—and this one fit the bill.

Now, I bought the stock because I did believe the Street was wrong on its Brent-WTI consensus. I did my research and I was right. But I confess I sold the stock and got the high because of dumb luck. It was spring break and I was heading to Orlando for 10 days. I had bought the stock on margin and I didn’t want to watch it while I was visiting Mickey with my kids.

Ask any geologist—he’d rather be lucky than good. That was one of my biggest wins of 2013. I’ve since given back small pieces of that win on that stock…;-).

Then I went really outside the box—buying ethanol stocks. Ethanol stocks are refineries—just for corn. The Market has hated ethanol stocks—with good reason. The drought of 2012 spiked corn prices and smashed ethanol profits. The stocks cratered.

I had been watching Green Plains Renewable Energy (GPRE-NASD) since May 2012 at $10. I watched it go to $4 so fast that summer I could hardly believe it! Thru the fall and winter it fought its way back to $8, and then in February 2013—as USDA stats showed record corn acreage being planted—the stock gapped up and I started buying in at $8.70. I love buying breakouts.

GPRE has one of top quality management teams I have EVER invested with. They have shown they can sell at the top (selling corn and corn storage to Andersons in December 2012) and buying at the bottom (three new ethanol plants this year for very low valuations). They were able to diversify revenue outside of pure ethanol—all the while keeping their share count low.

There are only 30 million shares out, 34 million fully diluted and they now produce one billion gallons of ethanol a year—that’s leverage. I like leverage. If you have over 100 million shares out, that’s strike 1. Over 200 million—strike 2. Over 300 million, you’re out. There are exceptions, but you get my drift.

I grew up on a farm, so I knew a bit about corn, but this year I learned more about weather patterns, heat units, yield, ethanol yield, the Renewable Fuel Standard and RINs than anyone should have to.

And as a record corn crop looked more inevitable (and it did come through), corn prices dropped all the way down from $7 to $4.20 a bushel. Investors started pricing in progressively higher margins for ethanol producers and GPRE stock hit $18 this year, and still trades at $16.50. I have a token position left—I started selling at $14 on up. (I switched into a new ethanol producer trading at just 1.5x my expected 2014 cash flow!)

Not many subscribers bought into the trade, however—despite my enthusiasm for the story. And in February-March, I was really enthusiastic on this one. I don’t have any opinion on ethanol as a fuel—my job is to work the rules and make money. And I saw an opportunity to make a lot of money—with a really high quality management team.

As a newsletter writer, you want your subscribers to heavily own the winners—you know, so they keep paying you—and to make up for the inevitable dogs that come around every now again.

But ethanol was so “outside-the-box” that few subscribers felt comfortable with it. And I think that’s key—when you subscribe to anyone like me, there are always lots of different picks and you have to choose the ones in which you have the most conviction.

Those two stocks encapsulate much of my 2013 strategy—more US stocks, more senior stocks. But both were pure plays with a lot of leverage and strong management teams.

What didn’t work so well in 2013? 

Several stocks and entire themes not pan out. For example, this summer I got excited about the potential for LNG—Liquid Natural Gas—construction right here in British Columbia. It takes about $7.5 billion to build a facility that will export 1 billion cubic feet of gas per day (bcf/d).

There are now 14 proposals to export a total of more than 14 bcf/d—ALL of Canada’s production! That’s over $100 billion in potential capital spending over the next decade.

Any one of those proposals saying they were definitely moving ahead—would ignite the whole sector.

Only problem was, nobody said they were ready to move ahead. I ended up selling most of those stocks for just a 5-10% profit, and I’m now waiting for a new catalyst.

As a silver lining, I did discover one company—Macro Enterprises (MCR-TSXv). It was a $150 million company with 79 cents a share EARNINGS—trading at $2.25 when I bought it in mid-May. That’s 2.86x PE, and it was trading 2.5x cash flow—compared to a peer group of 9x cash flow. It had no sell side analyst coverage—not one brokerage firm followed the story.

They keep winning new business and the stock now trades about 6x cash flow $6.50 and I took some profits at $7.34, one penny off the all-time high of $7.35. I didn’t catch the top because I was smart; I just thought 7x cash flow at the time and a triple to boot was good enough reason to sell some stock.

The technology sector of the oilpatch has been my real weakness. Every year for the last three I have impaled myself on one stock in this sector—what I think is a great story only to be foiled by a company not meeting expectations.

This year it was RDX Technologies (RDX-TSXv), formerly called Ridgeline. CEO Dennis Danzik has a novel technology that truly turns waste fluid—which people pay them to take—into biodiesel, which customers pay to buy. The business is actually doing very well—generating some $400,000 a month in positive EBITDA—but expectations were for much higher.

And as those expectations weren’t met, the stock dropped from 55 cents to 13 cents, and I bought A LOT in the mid-30s. It’s trading around 20 cents now. I still own every share…sigh.

While the company is actually more profitable now than ever before, management will have to spend the next 2-3 quarters gaining back the trust of its shareholders and analysts by properly guiding the market in its forecasts.

And then there are the stocks that you think have so much potential, but the Street won’t buy them. I’ve owned a very small position in Iona Energy (INA-TSXv) for three years, thinking management will move the company forward. They are over two years behind putting their first asset in the North Sea into production—called Orlando.

But in January this year they bought 15% of a winning asset—called Huntington. It’s now producing great—but the stock can’t break out. Sigh. I still own it all, but it’s been quite frustrating.

But I actually did OK for subscribers on the junior producers. My 2012 purchases, DeeThree (DTX-TSX) and Raging River (RRX-TSX), just kept chugging to new highs.  Both should continue to make shareholders prosper in 2014.

Again, they weren’t all winners.  I keep tight stops on most purchases—and I was stopped out of a few of my producers.

The key is, shoot your losers fast and hope the ones in which you have really high conviction—and therefore put a lot of money into—work out.

I had two new producer picks like that that did really well—50% for one and a whopping 500% for the other.  The 6 bagger (that’s a 500% gain) was the most junior, lowest priced stock I’ve ever bought—that just happened to have the one of the best teams in Calgary take it over dirt cheap.  These teams rarely play in the public markets anymore, preferring to operate privately.

Overall, the US energy industry had much better looking charts than in Canada.  That’s why I went there.  There were really only 6-8 junior stocks in all of Canada that did well.

Between fast-rising oil production and fast-increasing pipeline capacity, the energy sector has a lot of opportunities—and a few pitfalls. But overall, I’m pretty happy with the way 2013 worked out.

Happy Holidays,

– Keith

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