Yesterday morning Nostra Terra Oil & Gas (LSE:NTOG) announced it had secured the remaining 12.5% of the Pine Mills oil field, Texas. Nostra now owns 100% of Pine Mills, effective since 01 November 2016 when it became operator. The company’s share price responded positively to the news, rallying 15% to close at 1.55p. This values Nostra at £1.89million, but is the market applying too harsh a discount to this company’s genuine turnaround story?
Since it embarked on its new strategy in the middle of last year, Nostra has battled against a number of headwinds. The collapse in the oil price, from late 2014, was the catalyst for a near-terminal collapse in its stock price. Nostra’s previous strategy was no longer viable and the company took the extremely difficult decision of writing off its uneconomic assets. By the end of May 2016 the situation was looking pretty bleak and Nostra was forced to complete a dreaded capital reorg.
But then things started to improve.
Just when it seemed it might be doomed, Nostra was thrown a lifeline. On 29 June 2016, the company announced the surprise $2.1million sale of its stake in the Chisholm Trail prospect. Better yet and by December that year, Nostra confirmed the sale price had increased to $2.7million. Nostra was able to sell its minority interest in the producing, stacked-play Chisholm Trail prospect because this was one of the few areas still with attractive fundamentals onshore USA. The asset had retained its value and Nostra’s board wanted to restructure the business.
The timing of the Chisholm Trail sale could not have been better. It marked a clear inflection point for Nostra. The sudden injection of capital enabled the company to pay down debt (which fell by $520,000 during FY 2016) and, more importantly, secure new assets to reposition the business.
And it is those new assets that the market could well now be underestimating.
By late 2016 Nostra had bought its initial 80% stake in Pine Mills and secured its first of two license areas in the prolific Permian Basin, Texas. The latter acquisition drew much mirth on Social Media thanks to the low production rates, with one online wag suggesting Nostra’s directors would produce more oil by taking a can and hose around their local neighbourhoods to syphon off fuel from residents’ cars!
As much as I’m amused by that comment, it does reflect a wider problem facing Nostra today. Very few investors seem to believe its turnaround story. If you look at the company’s share price performance over the last year, Nostra looks like a stock that is still being priced to fail. I was even sent a message recently by one well-known City figure, who asked “haven’t they run out of money yet?”
This sort of lazy, throwaway assessment of a company’s prospects demonstrates illustrates the extent to which a previous failure can excessively bias people’s investment view. It also creates opportunities for those who can see beyond superficial judgements and are prepared to dig deeper to unearth potential gems.
Nostra’s CEO, Matt Lofgran, has repeatedly gone on record to explain that the company’s new strategy is built on cash flow generation. In repositioning Nostra’s portfolio Lofgran has sought to acquire producing assets, which Nostra can control as operator. The Pine Mills acquisition is the centrepiece of this plan and represents nearly all of Nostra’s announced production. Over the last four months Pine Mills has averaged 106 barrels of oil a day (“bopd”), which is up from a four-month average of 91bopd when Nostra took over ten months ago.
However, as encouraging as the sustained oil production increase is, it is only one side of the cash flow generation coin. The other side is often overlooked and is arguably even more important: a company’s proven oil reserves (“1P”).
In the simplest terms 1P proven reserves represent money in the ground. There is very little technical risk that the identified oil is present and can be extracted profitably. A company can confidently build a financial model around 1P proven reserves, based on solid cash flow generation. This gives an oil producer a firm platform to grow on by further developing its undeveloped 1P reserves and conducting exploration to convert 2P possible reserves into the 1P proven category.
This is what was so significant about Nostra’s Texas Assets Reserves Report, which it released last April. By focussing solely on documenting its 1P proven reserves across its Texan portfolio, Nostra put in place a bankable foundation on which to build its growth strategy.
For a company of Nostra’s size the numbers in its Reserves Report are impressive. At Pine Mills, Nostra’s 1P proven reserves now have a $4.03million NPV10 valuation (on 326,000 barrels of oil), while its Permian assets have a combined NPV10 of $1.04million (on 196,000 barrels of oil). The total $5.07million estimate compares very favourably to Nostra’s £1.89million market cap and there is plenty of scope for further upside. Nostra plans to increase production at Pine Mills (ultimately targeting a sustained150bopd) and develop its 1P Permian reserves, 92% of which are currently undeveloped. Given the prolific nature of oil production in the Permian Basin, the two licenses Nostra owns there could easily amount to the equivalent of another Pine Mills in the not too distant future.
Of course, to execute this plan will require additional working capital. For a company of Nostra’s size this has traditionally been the problem. Discounted placements can be horrible value destroyers, but Nostra has developed its strategy with a different goal in mind. Nostra plans to hedge future production to help fund its working capital requirements.
More information about hedging oil production can be found HERE and HERE, but one striking feature of Nostra’s announcement yesterday is that the company believes it can now access a hedging facility. Unlike a company’s market cap, which is subject to fickle market forces, hedging facilities are offered by professional lenders. The commercial standards applied to these are demanding and they are only made available to companies, which can demonstrate sustained oil production.
Now that Nostra has been operator of Pine Mills for 10 months, and given the progress it has made operationally (cutting costs and increasing production), if the company can secure a hedging facility this would be a notable endorsement of its new strategy. What happens to the share price is anyone’s guess, but so long as Nostra keeps making commercial progress its target of becoming cash flow positive at the Plc level draws ever nearer.
The author of this piece owns stock in Nostra Terra.
The author of this piece is contracted by Nostra Terra for the provision of certain writing services.
The author of this piece has not been paid for writing or publishing this article. It is independent analysis.