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Tap Energy Profits with Undervalued Producers: Chen Lin
Source: George S. Mack of The Energy Report (2/28/12)
The idea of finding an undervalued stock is enticing, but how can investors distinguish between an international value tap and a bottomless money trap? Private investor and newsletter writer Chen Lin combs every continent to find junior exploration and production companies whose balance sheets outshine low stock valuations. In this exclusive interview with The Energy Report, Lin shares some lesser-known names that offer major profit potential.
Chen Lin: Yes, but I look more at the fundamentals. Greece is on the edge of bankruptcy, but I think the market is well prepared for that. I'm looking more at whether there's a major impact to the financial markets.
TER: How would it affect the way you trade?
CL: If we have another round of a huge deleveraging, I think I will be more conservative in general. I've become very aggressive in my investing since the beginning of the year because the European Central Bank (ECB) did another round of money printing and low-interest loaning to all the banks for three years. That dramatically expanded balance sheets, just like quantitative easing (QE) did in the U.S.
TER: You have had stellar returns in your portfolios. You grew $5,411 as of Dec. 31, 2002, to $1,383,041 by Dec. 31, 2011, but your portfolios were down 11% in 2011. What were the issues that resulted in that downturn?
CL: In 2008 I had a down year by a similar amount. I usually invest mostly long in the market, and I like to invest in undervalued stocks. Sometimes if they are extremely undervalued, I overweight them. So that tends to concentrate those stocks. When the market is down and investors don't recognize the value, my stocks can be dragged down along with the overall market. Considering how tough the market was in 2011, I think I did relatively well in the period. I'm up quite significantly since the beginning of this year. People were seeking refuge in U.S. Treasury bonds, and now are suddenly starting to put money back to work. There has been a huge run-up of commodities and commodity-related stocks.
TER: At the end of 2011, you said that energy stocks were on a year-end clearance sale. After some price appreciation, are they still on clearance?
CL: A lot of the stocks I own have already appreciated dramatically since the beginning of the year, some even close to 100%. However, because they went down very hard last year and people panicked and sold everything they could to raise cash, I think there are still a lot of extremely undervalued energy stocks right now. Historically, if you compare the risk-reward, they're still extremely undervalued. So I'm still overweighting energy versus precious metals.
TER: Are you currently trading out of equities that have greatly appreciated since the beginning of 2012?
CL: No, I am not. Well, some stocks I have, but mostly I've stayed with what I'm holding. I believe this rally still has legs. My largest position is Mart Resources Inc. (MMT:TSX.V), and my second largest is Pan Orient Energy Corp. (POE:TSX.V). Although I've been mentioning them in my newsletter for quite some time, I am still holding and riding those two stocks. I believe they are still very much undervalued.
TER: You've written that you're expecting some big news from Mart pretty soon.
CL: I'm hoping the company can deliver a dividend. Its cash has been increasing dramatically in the past few months. It's going after light sweet oil in Nigeria and selling it at a premium to Brent crude, so the company has a lot of free cash flow. The money is just piling up on its balance sheet, and I expect that to continue for the rest of the year. It's pretty amazing that only two years ago the company was close to bankruptcy. Since then, it has just changed dramatically, and I don't think it is appreciated by the market. I'm still very optimistic about the company and holding my position.
TER: Mart Resources has given back about 6% over the past month. Is this a buying opportunity?
CL: I think so. If you compare the valuation of Mart to other companies in the space, seldom do you see a company trading potentially at one or two times this year's cash flow. Potentially, it could more than double its cash flow next year because it is finding more and more oil. Every well has been great in the past two years. That's very unusual for a junior company. In addition, its wells have no decline. That's something that amazes me because if you look at nearly all energy companies, you're looking at very sharp declines in the first three to six months.
TER: Is there no sign at all of depletion? This huge oil field just continues to keep producing?
CL: That's the thing. My guess is that it is sitting on a huge oil pool that's interconnected and extends over a very big range. Once it pumps oil out, still more oil flows to the area, and so there's no decline. This type of well is very hard to find on earth except in Saudi Arabia and a few other countries.
TER: So, Mart is producing oil that gives the company a marketing advantage because light-sweet refinement is low cost and therefore commands a premium price to Brent crude. Plus, depletion is not notable yet. What am I missing? I'm sure the picture can't be this bright.
CL: Exactly. Well, the issue is Nigeria. It is a country where there are frequent protests and attacks on the pipelines. But those conflicts are mostly in the north, whereas Mart operates in the south, near the coast. So it's pretty far away from the major violence. There is still tremendous opportunity and tremendous cash flow for this company. I think this will be the year when people see a dramatic rise in cash on its balance sheet and hopefully, with all that cash, it can pay dividends and bring in more rigs. It will build a pipeline and do everything organically without coming back to the market. That's the beauty of this.
TER: A year ago you said you expected investors to begin accumulating shares in Pan Orient based on anticipated production from its big land position in Indonesia. You were correct. Shares are up more than 60% over the past three months. How much more growth can we expect?
CL: Pan Orient has a slightly different thesis than Mart Resources because there is some exploration/discovery risk. It is drilling wells, potentially very big wells, but I don't know if the wells will be successful. With Mart, there is much more certainty. However, though there is risk for Pan Orient, it is a very experienced oil exploration company, and it's been in Thailand for five years, drilling and fine tuning its technology.
I shared with my subscribers a report that estimates each of the three Pan Orient wells in Indonesia is worth about $3 of net asset value (NAV)/share if successful in the first half of 2012 and $2 for each of the other three wells in the second half of 2012. In addition, Pan Orient also has an oil sands property in Canada that it wants to sell. The company has $1/share cash on the balance sheet and cash flow over $1/share right now, and this is in addition to the oil sands property that it has for sale. Thailand is ramping up production and Indonesia has the big wildcat wells at work. So in terms of risk-reward, it's an ideal situation. I wouldn't be surprised to see the stock be a ten-bagger by the end of this year. The company could be a $1 billion (B) company. It was a $2 stock when I recommended it in my newsletter. Right now it's $3 and change. With some success in drilling in Indonesia, I'm looking for a ten-bagger. Seldom do you have those in one year, so I have pretty high hopes on the stock.
TER: What other companies do you like?
CL: This year, I have put a new fracking company in my newsletter, New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX). It has done very well so far. The stock has really exploded, and some of this excitement is about the company getting ready to explore for shale oil in New Zealand. The company has a big land package, and I think Apache is going to start drilling in April not far from their huge land package, and so we may see some results in H212. In the mean time, the company has drilled a nice conventional well, which has 500 barrels per day on restricted flow. It is drilling the second well and planning the third. The success of the current drilling program can move the stock as well.
I still have Porto Energy Corp. (PEC:TSX.V) on my list. It was one of my biggest losers last year. You win some and lose some. The stock has been down to about $0.11 recently, but I'm seeing significant insider purchases. The company has about $10 million (M) in working capital, but it doesn't intend to use all the money to drill the well on its own and then have to come back to the market to raise money at this depressed level. Instead, it is looking to do a joint venture (JV). So basically it would like its partner to pick up the costs and risk. I just spoke with the company, and management is still optimistic about getting a JV deal very soon. Porto is unique in that it has a huge land package in Portugal of over 1M acres on trend with the North Sea.
TER: You've said that the Portuguese government wanted to do anything it could to help Porto, and so it's disappointing to see that the stock has been so weak. What is the government doing to help the company?
CL: I think the government is making it easier to get permits. Porto has drilled three dry holes. It hasn't found any major oil yet, and that was its big downfall last year. I was told last year that if it found oil it would be easier to work with the government to bring the oil into production.
Portugal is trying to do everything it can to avoid the fate of Greece, and so an oil discovery would be very significant. Porto is being run by very experienced oil guys, and most of them came from Devon Energy Corp.'s (DVN:NYSE) international division. In fact, Joe Ash was running the International division, but he left a comfortable, high-paying job to run Porto because he believes in the potential. You can see from insider trading reports that he has recently purchased more shares with his own money. So that tells you the people still believe in the whole thesis of finding massive amounts of oil in Portugal.
TER: At this low $25M market cap, it seems like Ash with a few other people could easily buy this company and take it private.
CL: Yes. But when the stock went down, the company adopted a poison pill. I think it's afraid of a hostile takeover. Taking it private is possible.
TER: You mentioned New Zealand Energy. Its shares, as you indicated, have gone to the races. The company is up well over 100% over the past three months. That's a lot of conviction.
CL: I believe there is the potential of doing fracking on this Bakken-like land. There will be some development later this year, and that's actually driving the stock price. This stock is still very undervalued.
TER: Are there other companies you like?
CL: There are quite a few still that I like. PetroBakken Energy Ltd. (PBN:TSX) has been a big winner for me. It was paying a 10% dividend when I picked it up, but it's up almost 70% since then, and now it is paying a 6-7% dividend. The key is that if you compare the company with other North American-based fracking companies in Bakken plays, it's still relatively cheap. I think it could potentially have more upside, but the easy money has been made with this stock.
I am also holding Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) and Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE). Both stocks are rising this year. I like Prophecy Coal as it is getting close to a contract with Mongolia's government. That will lead to financing and construction of the power plant. Prophecy Platinum should have its preliminary economic assessment very soon, so investors can get a peek of the project's huge potential.
TER: Most of your stocks are microcap companies. I find it interesting that you own Petrobakken, which has such a large market cap at $2.8B.
CL: As far as market cap, it's one of the largest I own now, but it had been hit very hard, and thankfully I was able to pick it up when it was quite depressed.
TER: What about another company that you like?
CL: Another company I like, which still hasn't appreciated much, is Harvest Natural Resources (HNR:NYSE). This company has had bad luck like Porto. It drilled three dry holes in a row, and the stock is still very close to its 52-week low. The main attraction is that it has a big oil field in Venezuela. If you are looking at normal valuations, and if it's not in Venezuela but rather a country friendlier to the U.S., then the company is probably worth at least $20/share. The stock is trading at $6–7. Venezuela is going to have an election this year in the fall, and Hugo Chavez will be seeking his third term. With all the things happening around the world, like the Arab Spring, I wouldn't be surprised if Venezuela has some major changes this year. If that's the case, this stock can have a huge upside.
TER: Harvest Natural just hit another dry hole, but clearly the dry holes don't make you as nervous as the Venezuelan government, is that right?
CL: If it gets a hit in Indonesia that would be great. But this company already has a huge oil field in Venezuela that is self-funding. It doesn't need to put money in. It was hoping to get money out as dividends for shareholders, but so far it has been having trouble getting any money out because of the government. But this could change overnight if the government has a change of regime.
TER: What other companies did you want to mention to us today?
CL: Another company is TransGlobe Energy Corp. (TGL:TSX; TGA:NASDAQ), which I own. It is operating mostly in Egypt and Yemen. If you compare the company, cash-flow wise it is very, very cheap. Due to political problems, the company has mostly stopped production in Yemen. If it can start flowing again in the country, that would be another big catalyst. I like the stock, and I own the stock and options.
TER: What effect has the Arab Spring in Yemen had on TransGlobe's business? Its shares have been above water for the last six months.
CL: The Arab Spring in Yemen actually depressed the stock. It used to produce from Yemen but because of violence, it stopped producing there. Any peaceful resolutions and new production would be a big plus.
TER: Any other positions you could talk about briefly?
CL: I also have two companies in the North Sea. Both did very well. One is Ithaca Energy Inc. (IAE:TSX). It just went up 40–50% because of a potential takeover. Another is a Iona Energy Inc. (INA:TSX.V), which was funded by the founder of Ithaca Energy. Both of these have done very well.
TER: Do you have any new positions?
CL: I recently purchased Coastal Energy Co. (CEN:TSX.V), operating in offshore Thailand. It has been growing its production quite dramatically in the past year, and it continues to grow.
TER: Coastal is another larger name with a $2B market cap. But just the opposite is Groundstar Resources Ltd. (GSA:TSX.V), which you owned last year.
CL: Yes. Groundstar was one of the worst stock picks I had last year. It drilled a well in Iraq and one in Egypt, and every well it drilled turned out to be a dry hole. So I had to cut my losses and get out of the stock when I saw it was raising money and diluting shareholders at a very low share price. The stock would have probably had a difficult time rebounding.
TER: It is so nice speaking with you again, Chen. Thank you for your time.
CL: I enjoyed it. Thank you.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc. While a doctoral candidate in aeronautical engineering at Princeton, Lin found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.
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1) George S. Mack of The Energy Report conducted this interview. He, personally and/or his family, own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Mart Resources Inc., New Zealand Energy Corp., Prophecy Coal Corp., Prophesy Platinum Corp., Iona Energy Inc. and TransGlobe Energy Corp. Streetwise Reports does not accept stock in exchange for services.
3) Chen Lin: I personally and/or my family own shares of the following companies mentioned in this interview: Mart Resources Inc., Pan Orient Energy Corp., New Zealand Energy Corp., Porto Energy Corp., Devon Energy Corp., Petrobakken Energy Ltd., Prophecy Coal, Prophecy Platinum, Harvest Natural Resources Inc., TransGlobe Energy Corp., Ithaca Energy Inc., Coastal Energy Co. and Groundstar Resources Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: In early 2010, when Porto Energy was a private company, Chen Lin received shares from the company to introduce it to hedge funds. I was not paid by Streetwise for this interview.