Touchstone Exploration, positive start on AIM could cause the share price to rerate TXP

Since Touchstone Exploration (LSE:TXP) debuted in London just under a month ago its share price has risen 20%. It now trades at 8.75p on the bid (last seen). Touchstone is an oil and gas company, with onshore operations located in Trinidad and Tobago. In its latest quarterly report the company announced oil production had increased to 1,335 barrels per day (“bopd”). As I recently reported, Touchstone’s £7.3million market cap values the company favourably compared to its direct peers on AIM. This implicit undervaluation is encouraging, but improving fundamentals suggest a re-rate could soon be on the cards.

When Touchstone came to AIM it raised £1.45million at 7.25p. The company’s plan is to increase oil production to 2,000bopd by 2018. Its pitch was it would achieve this through development of its low cost reserves (C$7.35 per barrel of 1P reserves and C$6.00 per barrel of 2P reserves) and lean operating model. One of the attractive aspects of Touchstone’s assets in Trinidad and Tobago is they are forecast to have low decline rates, suggesting both longevity of operations and resilience to the persisting low oil price.

For private investors this almost sounded too good to be true. Compared to a lot of the rubbish in the lower reaches of the oil & gas sector on AIM, here is a company presenting a credible operational plan, trading at a modest price. Better yet and the board has been talking up the prospects of dividend payments!

In the words of CEO Paul Baay, “When we set up Touchstone our goal was to create a dividend paying business. We were on our way there until oil turned south a few years ago. Moving forward this is still our plan, but it will largely be a function of where the oil price is. However there are also operational improvement we can make to ensure the business is run as efficiently as possible, including reducing drilling and operating costs.

This sounds great, but how much is a cynical market likely to believe this story?

Judging by Touchstone’s news flow over the course of its first month on AIM, it seems likely it won’t take long for it to win over more admirers. The company’s Q2 operational report is certainly promising.

During June, Touchstone brought two wells into production on its Coora Block. Well CO-368 produced 111bopd for its first 26 days of production and Well CO-369 produced 151bopd over its first 17 days. These wells obviously had a positive effect on Touchstone’s overall production rate. In the last quarter this rose to the 1,335bopd already quoted and it rose again in the first 17 days of July to 1,455bopd.

As positive as the contribution from Coora has been, Touchstone’s attention is much more focussed on developments in the WD-4 Block. According to Baay, the company “has had the most success at WD-4, which is its largest and deepest producing block. Having not drilled wells for a couple of years because of the price environment, we completed an extensive review of our assets. As a result of this we now want to look for deeper production horizons, which will bring into play new production and new reserves. This is exciting for the island and a cheap way to conduct exploration.”

As the final part of this summer’s four well drill campaign, Touchstone also drilled two wells at WD-4 (PS-598 and PS-599). These have encountered approximately 637 feet of net oil pay and Baay says, “based on performance of other wells at WD-4 we are expecting the two wells to produce at a sustained rate of 100-150bopd.” When asked why the company had not already released initial flow rates Baay replied, “releasing initial flow rates is not our style. The data is extremely unreliable. Our policy is to wait until we have gained a good idea of stable flow rates, before updating the market.

Assuming PS-598 and PS-599 meet the lower end of Baay’s expectations, by the end of summer Touchstone could be producing about 1,700bopd. This is not far off the target of hitting 2,000bopd by 2018. Looking to the future Baay commented, “our operational goal is to have one rig continuously drilling on the island. This will bring more wells into production and improve the company’s cash flow generation.

This suggests the company has plans to drill more wells in the second half of the year, not least because of the importance of generating increased cash flow.

Touchstone is going to need this because one area to be mindful of is its debt. On 23 November 2016, Touchstone received a $15million loan from a Canadian investment firm. The interest rate is 8% and principal payments are due from 01 January 2019. The loan matures on 23 November 2021. Touchstone explains this in more detail in its Q1 report, but Baay believes the main point to take home is “that the company’s debt is manageable. The interest rate is reasonable considering market conditions and Touchstone has built into its plan the provision to start making principal repayments in 18 months time, from internally generated cash flow.

Touchstone’s reported financial performance in the first quarter of the year supports Baay’s belief. Although Touchstone lost C$1.1million, this was down from C$3million the year before. However, Touchstone’s operating profit during the period (including general and administrative expenses) was C$1.3million. Assuming increased production has not led to a significant increase in operational expenditure, this bodes well for Touchstone’s next set of reported figures. These are due out on 11 August.

If Touchstone can demonstrate continued financial improvement as we move further into 2017, expect the market to sit up and take note. The £7.3million market cap could start to look cheap, as investors buy into the business’ potential.

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