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Time to Join Insiders in this Exotic Foreign Energy Play
By Michael Brush
Exclusively for InvestorIdeas.com
June 08, 2007
Contrarian investors love stocks that are bruised and battered – stocks that no one else will touch. This style of investing can be quite rewarding. The Dreman Small Cap Value fund (KDSAX), run by one of my favorite fund managers and long-time contrarian guru David Dreman, is up 14.39% a year over the past five years. It has beaten its category by two percentage points a year.
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But to get returns like that, you have to have both the courage to get involved with troubled stocks, and a reasonable level of confidence that you are doing the right thing. I’ll leave the first part up to you. But for the second part, we can count on the insiders to show us the way.
Recently they’ve been pointing to a compelling contrarian play known as Toreador Resources (TRGL), a smallish energy company with vast, potential energy reserves in emerging countries like Romania, Hungary and Turkey.
All of these countries carry a lot more political risk than the Barnett Shale in energy-friendly Texas. But political risk is perhaps the least of Toreador’s recent problems.
In the past several months it has:
- Undergone a boss-ectomy of sorts, losing both the chief executive and the finance chief – the former has been replaced
- Reported a decline in revenue thanks to wells that failed to produce and severance costs for the former CEO
- Come up dry on six exploratory wells in Romania, Hungary and France
- Gone to market to raise $45 million
- Hired auditors to go over the books because of questions about some of its accounting
“The company has gone through some tumultuous times,” chief executive Nigel Lovett told me in a recent interview. That’s putting it mildly. Any one of those events would leave investors wondering -- and trimming positions to be on the safe side. But put them together, and you get the kind of exodus that can drive a stock down nearly 50% to $15 from $28 since the start of 2007, exactly what has happened to Toreador.
Talk about a bad year.
The insider buying
But I believe there’s light at the end of the tunnel – even if investors are selling hard and research shops like Jefferies & Co. are telling you to stay way. Here’s why.
Since the end of March insiders have purchased $2.5 million worth of the stock at prices between $13.19 and $18.44, with most of the buying in the $13-$14 range, according to InsiderScore.com. That’s a significantly bullish signal by any measure, but especially at a small company like this. Toreador has a market cap of just $300 million.
Plus the new CEO – who is among the buyers -- has a pay package structured to reward him the most if the stock goes up. More on that in a moment. First, what might actually make the stock turn around? I’d look to the following factors.
Production finally coming on line
In late May, the company announced it started production in three wells on its Akkaya platform in the Turkish Black Sea – at 20 million cubic feet of gas per day. Full production should reach 50 million cubic feet of gas a day by the third quarter.
The project is part of its South Akcakoca Sub-Basin project which is a joint venture with the Turkish national oil company, TPAO and Stratic Energy. Toreador has a 37% interest in the project. The production is the first ever in the Turkish Black Sea.
Improving cash flow and financial strength
This production is putting Toreador on a better financial footing. The company should have about $12 million in cash flow per quarter from these projects by the third quarter. Throw in the $6 million a quarter from other production in France and the U.S., and the company will be up to $18 million a quarter in the second half.
And what about capital spending? That’s set to hit $81.5 million for the year, $27 million of which will fall in the second half. The key is to compare that to the $36 million in cash flow Toreador will generate in the second half.
But what about the rest of the capital spending, a good piece of which is happening this quarter? The company raised $50 million in March and April, and as of the end of March it had $43.9 million in cash. It has a $15 million facility with the International Finance Corporation, the private sector arm of the World Bank. The facility kicks in once gas production clears hurdle levels in Turkey. The company is also raising about $5 million by selling off two tech investments. “I do not see a need to access the capital markets through 2007, and potentially well into 2008,” says Lovett.
Bigger potential, but credibility problems
Toreador appears to have much more potential. But it’s not getting credit for it -- and this is partly what makes it a good contrarian play. It has only drilled on 50,000 acres out of the one million acres it has the rights to in the Black Sea. As Lovett likes to point out, it’s unlikely the company just got lucky on the first try in that vast holding. There’s likely much more potential in the Black Sea. Toreador also has additional untested acreage on- and off-shore in Turkey, and in Hungary and Romania, where it is currently drilling an exploratory well. The results should be available some time this quarter.
But given the record of broken promises, investors offer Toreador little, if any, credit for all of this. “We obviously got ahead of ourselves in pronouncements to the market as to when we could bring on gas discoveries,” says Lovett. “The market has been very unforgiving of that, and I respect that.”
Part of the problem is that Toreador is in “frontier” areas. It is “the first foreign and maybe the first private sector company” in the countries where it plans to operate, he says. When Toreador first started making plans in Romania, the country didn’t even have the regulatory structure to deal with a foreign company producing there. Waiting for the government to get up to speed there has caused delays and hurt Toreador’s credibility.
Help from the Russian bear
The solution is to be more careful now about making predictions on production, and to simply “perform and execute to get our credibility back,” says Lovett. That sounds like a plan – but the company is dealing with government bureaucracies and state-owned energy companies that are heavily influenced by politicians who don’t always have a great deal of respect for the marketplace. More surprises may be in store.
One factor in Toreador’s favor is that all of the countries in Eastern Europe where it has drilling rights are big importers of energy from Russia. Given how Russia has become more erratic and willing to use energy as a political tool, these countries should be keen to develop their own supplies with Toreador.
CEO incentive pay
Besides getting a base salary of just $60,000 a year, Lovett gets a bonus which won’t offer him much compensation unless he hits targets. And at least half his bonus will be paid in stock. He also has incentive stock which vests in tranches over several years.
The bottom line : Toreador is in countries that are new to dealing with foreign energy companies, so you should expect more growing pains. But insiders are saying the stock market is being too harsh in this regard. I don’t know if David Dreman owns this stock, but I’d buy shares right here. Just be prepared for some volatility.
Disclaimer
At the time of publication, Michael Brush owned shares of Toreador. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner:
http://www.investorideas.com/insiderscorner/. InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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