Canacol Energy Ltd

Canacol Energy Ltd (TSX: CNE) is a natural gas and oil exploration and production company, which operates in Colombia and Mexico. The company holds an interest in Oleoducto Bicentenario de Colombia which owns a pipeline system that focuses on linking Llanos basin oil production to the Cano Limon oil pipeline system.

Investment Rationale:

• Reaffirmed Guidance: Despite the slow recovery from the COVID-19 pandemic in Colombia, the Corporation expects its sales to be inside the previously released guidance range of 170 MMcfpd and 197 MMcfpd.

• Ample Liquidity: Amidst a sluggish industry scenario, the company has an impressive balance sheet and strong liquidity levels of ~USD 58.6 million of cash balance, which seems sufficient to withstand the current economic jolt. Further, the company expects that it would fund its dividend program and required capital from existing cash flows, which is a key positive.

• Capacity Additions: The group is currently completing the Pandereta-8 development well, which encountered 168 feet true vertical depth of net gas pay. Utilizing a second rig, the Corporation has also recently spud the Porro Norte-1 exploration well and anticipates well results to be released once the well has reached total depth and has been logged. Furthermore, the company is expected to conduct two drilling rigs under contract, Pioneer 53, and Pioneer 302, and plans to drill 4 additional wells during the rest of 2020.

• Lucrative Dividend Yield: At the last traded price, the stock was offering a dividend yield of ~5.8%, which is lucrative considering the current interest rate environment.

Q2FY20 Financial Highlights:

Q2FY20 Income Statement Highlights (Source: Company Reports)

• CNE posted revenue of USD 60.513 million, as compared to USD 49.928 million in the previous corresponding period (pcp), driven by higher income from natural gas and crude oil segment.
• Total expenses stood at USD 39.468 million, against USD 29.577 million in Q2FY19, due to a higher transportation expense, a surge in the depletion and depreciation and a higher Stock-based compensation and restricted share units’ expense.
• The company reported an impressive bottom-line of USD 17.715 million, significantly higher than USD 1.878 million in pcp, supported by an income tax recovery and a lower net finance expense.

Risks: The group performance is correlated to the demand and price of oil and gas. Any volatility in the prices of oil & gas would affect the group’s performance.

Stock Recommendation: The stock of CNE corrected ~24% so far this year.  Despite the slow recovery from the COVID-19 pandemic in Colombia, the Corporation expects its FY20 sales to be within the previous guidance range of 170 MMcfpd and 197 MMcfpd. The company entered into two new credit facilities with Credit Suisse, which would ensure sufficient liquidity. Amidst an ongoing slowdown in the industrial and manufacturing activities, the company's operations stood relatively uninterrupted during Q2FY20, which is a key positive and assures stability in its performance. The group saw an additional 8 MMscfpd of gas sales nominations during the month of July and August 2020, which is impressive. We have valued the stock using Price to Earnings based relative valuation method and have arrived at a double-digit upside (in percentage terms). For the said purposes, we have considered industry (Oil & Gas) average on NTM basis. Considering the aforesaid facts, current price movement, we recommend a 'Speculative Buy' rating on the stock at the closing market price of CAD 3.57 on October 20, 2020.

CNE Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

The Valens Company Inc

The Valens Company Inc (TSX: VLNS) is a developer and manufacturer of cannabinoid-based products. Its products are tinctures, capsules, beverages, and vape cartridges, among others. The company’s reportable segments are cannabis operations, analytical testing, and corporate. The company generates most of its revenue from Cannabis operations.

Investment rationale

• Building Capabilities to Capitalize on Growing Oil-based product: The company is increasing and improving custom manufacturing capabilities to keep up with expected oil-based product demand. Charts below Illustrate that in future, the market share of oil-based products will be around 75% and the company is gearing to capture that.

Source: Company Presentation

• Largest third-party extraction company: Valens is the largest third-party extraction company in Canada with an annual capacity of 425,000 kg of dried cannabis and hemp biomass at the purpose-built facility in Kelowna, British Columbia which is in the process of becoming European Union (EU) Good Manufacturing Practices (GMP) compliant.

• Record High Manufacturing: The company reported a record high manufacturing of 56 SKUs in the third quarter of 2020, representing a 56% increase from 36 SKUs in the second quarter of 2020.

Source: Company

• Expanding Geographical Footprints: The company made an agreement with Cannvalate Pty Ltd., Australia’s largest medicinal cannabis distributor and clinical research organization. This agreement gives strategic access to the Australian market, which is the second-largest legalized cannabis market outside North America. Under this deal, the company has made its first international shipment of oil.

• Market Positioning of new Cannabis-Infused Beverages: The Company successfully launched its first cannabis-infused white label beverage in Canada through its partnership with A1 Cannabis Company (a subsidiary of Iconic Brewing). The line of beverages includes BASECAMP, a CBD-forward iced tea, and SUMMIT, a THC-forward citrus water. Both products are available at select retailers throughout Ontario, Alberta, British Columbia and Saskatchewan.

Q3FY20: Financial Overview- (In Thousands of Canadian Dollars Except per share data)

Source: Company Filings

• Net revenue for the third quarter of 2020 was CAD 18.1 million, a 10% increase from CAD 16.5 million in the third quarter of 2019.
• Gross profit was CAD 7.3 million, or 39.5% of revenue, for the three months ended August 31, 2020, compared to CAD 12.8 million, or 77.8% of revenue, in the same period in fiscal 2019.
• Based on increased Depreciation cost, the company could not make the profits and posted a loss of CAD 3 million as compared to a profit of CAD 5.8 million on Y-o-Y basis.

Risk associated to investments

The products are new to customers and may not receive the acceptability from the consumers. Further, any regulatory changes related to cannabis would affect the company’s operations. 

Valuation Methodology (Illustrative):  EV to Sales

 All forecasted figures and peers have been taken from Thomson Reuters 

Stock Recommendation

The company is preparing itself to tap the oil-based product market, expanding its international wings in Australia, and manufacturing new SKUs. Also, the company’s financials are improving gradually, with substantial growth reported in the top-line. The launch of new products is likely to drive the group’s top line in the near future. Therefore, based on the above rationales and valuation, we have given a “Speculative Buy” rating at the closing price of CAD 1.68 on October 20, 2020 We have considered OrganiGram Holdings Inc, Rubicon Organics Inc as the peer group for the comparison.

VLNS daily technical chart. Source: Refinitiv (Thomson Reuters)

Disclaimer

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