(Idea) Strathcona Resources (Part 2)
Please read the first write-up here.
Note: Dollar references are to Canadian dollars unless otherwise specified.
Strathcona Resources (SCR:CA) is the newest intermediate-sized Canadian E&P to enter the public markets. We’re circling back to the name because we believe its shares could be an attractive long-term holding, as they offer tremendous upside if oil prices increase over the coming years, as we expect.
Analysis of Strathcona is challenged by the lack of publicly available data. It has only one full quarter of operating as a public company under its belt and, as such, has published just a single quarterly report. This report and management’s latest investor presentation are the only primary source documents outside investors have at their disposal to analyze the name.
We suspect Strathcona’s short stint as a public company and the lack of public information are factors that are limiting investor interest in its shares, particularly among larger investors.
As we see it, Strathcona possesses clear negatives and offsetting positives. While on balance, the positives win out, investors need to understand the headwinds the shares face before considering a purchase of Strathcona shares.
The Negatives in the Picture
Strathcona’s negatives are likely to depress its share price over at least the next few quarters. The most pressing relate to the company’s slim public share count. For the time being, there are few shares trading in public markets relative to the total number of shares outstanding. This reduces trading liquidity and increases share-price volatility.
Aside from the shares’ limited float, there exists a substantial overhang of shares held over from Strathcona’s reverse take-over of Pipestone Energy, by which it came public last September.
There is also a massive overhang of shares owned by the Waterous Energy Fund, Strathcona’s former owner. The fund currently owns 91% of Strathcona shares outstanding. Public investors own the remaining 9%.
Legacy Pipestone investors comprise part of that 9%. Moreover, many may be motivated sellers after having received a disappointingly low price for their shares in the deal. As new—and reluctant—Strathcona shareholders, their selling could put downward pressure on the shares irrespective of the company’s fundamental performance.
Longer-term, the Waterous Energy Fund shares are likely to be sold into the public market. The funds’ principals took Strathcona public in part to provide liquidity for their investors. This overhang increases the risk that large share sales overwhelm the volume of buyers, keeping a lid on price gains. Alternatively, it increases the likelihood that insiders sell in large blocks through secondary offerings. The company could opt to purchase the shares directly. If the shares are priced at a premium to intrinsic value, such a transaction would be dilutive, reducing intrinsic value per share for the remaining shareholders.
With regard to fundamentals, a notable negative is the diversity of Strathcona’s asset portfolio. Compared to oil sands operators such as Suncor Energy (SU:CA), Athabasca Oil (ATH:CA), or MEG Energy (MEG:CA)—all of which have spent years optimizing their asset portfolios—Strathcona’s operations are farther-flung and encompass a wider variety of activities.
Strathcona’s assets are weighted 77% to liquids. It produces oil and gas in three plays: Cold Lake Thermal, Lloydminster Heavy Oil, and the Montney, where it produces light oil. Its light oil operations produce condensate that feeds the diluent needs of its heavy oil operations.
The far-flung operations could result in higher costs than more focused operators. Infrastructure investments, debottlenecking, rationalization, and other initiatives are likely to be necessary over the coming years as the company integrates its portfolio and attempts to realize synergies among assets acquired over the past few years.
Strathcona’s final negative relates to capital allocation. The company was founded as a dealmaking vehicle, and dealmaking is probably still embedded in its culture. Future acquisitions and dispositions run the risk that management overpays for assets or makes strategic mistakes.
The former is of particular concern. We expect oil-weighted Canadian E&Ps that Strathcona could consider as acquisition targets to do well over the coming years. If they do and their share prices reflect their performance, Strathcona may have to pay a premium to acquire E&Ps that may be fully valued in the market.
We would like to hear management address all these negatives in order to provide more clarity on Strathcona’s strategic direction, prospects, and value.