Portfolio manager combines thorough research and contrarian approach
Seeking out oil companies that can provide long-term capital appreciation is a challenge, with the direction of barrel prices a source of constant speculation.
But Amar Pandya, senior investment analyst and associate portfolio manager at Penderfund Capital Management, believes his research approach gives him an investment edge in unearthing opportunities and market inefficiencies.
He highlighted two firms - Athabasca Oil Corp and Energy XXI Gulf Coast – as examples of how his thesis can work.
He said: “A significant disconnect between price and value can happen when a stock is too small, unloved or misunderstood by the market and this is something we can exploit.”
A recent report on oilprice.com said the Canadian oil industry had the highest growth in May, with the benefits of higher prices outweighing the negative effects of the pipeline capacity shortage.
While national GDP expanded by 0.5% that month, oil and gas posted 2.5% improvements, while the oil sands industry boasted 5.3% growth.
Pandya, however, acknowledged, that the energy sector is highly volatile and cyclical, with resource companies typically “capital intensive price takers subject to evolving regulatory risks”.
He also points out that, thanks to advances in shared oil extraction and declining barriers to new capacity, the oil price is more of a reflection of direct operating costs than capital employed, meaning that over a cycle, an oil producing company may generate low and often negative returns; proof that they are “generally structurally inferior businesses”.
Finding companies with long-term appreciation is, therefore, hard. But Pandya said that taking a contrarian view can help discover hidden opportunities. For example, behavioural biases and extreme pessimism – like the energy sector in recent years – can drag down stock valuations.
He said: “We also focus on idiosyncratic characteristics like hidden assets or special situations where the catalyst to unlocking value is not dependent on the underlying commodity price. Having small and nimble mandates allows us to take advantage of these limited opportunities when they arise in the market.”
Pandya said Athabasca Oil Corp was brought into the Pender Value Fund and Pender Canadian Opportunities Fund early this year despite the oil collapse in 2014-16 having driven down its shares 90% from its IPO price.
Upon digging deeper, Pandya found redeeming features, including a new management team and strategy focused on diversifying away from heavy to light oil. It had also found creative ways to raise capital, such as selling royalty streams that kick in only when oil prices are considerably higher than current levels.
“If there’s ever another bull market in oil,” said Pandya, “the company gives up a little bit of upside in return for valuable capital in an environment with constrained energy sector funding. The company also entered into a joint venture with one of their oil plays. It received a large cash payment and struck a unique capital carry agreement whereby it contributes only $75M on the first $1B of investment into the project, yet it maintains a 30% working interest. This agreement allows Athabasca to de-risk the development of the project that would be too large and capital intensive to complete on its own, while receiving favourable economics and optionality in return.”
From this position of strength, Athabasca was able to acquire the Canadian assets of Norwegian state-controlled firm Statoil, which was under pressure to exit the oil sands sector.
Pandya admits investing in these types of companies is not without risk but that inherent biases meant it was one worth taking, believing future catalysts could unlock the firm’s value potential.
He said: “Despite the new management team progressing on a successful transformation and the acquisition from Statoil, the share price continued to languish as its tumultuous history had left its mark on investor sentiment.
“Market inefficiencies can arise when investors get anchored to a specific view of a company. There is a tendency for investors to avoid or overlook an investment they were previously burned by, disregarding sell-side research as the bankers and brokers who had previously promoted the company have lost credibility. Our process allows us to take advantage of these sorts of situations where behavioural biases result in the mispricing of a security.”
