As alluded to in an earlier post, this site is will be put on temporary hiatus until further notice.

Since its inception, I’ve enjoyed (almost) every second of publishing this blog. Moreover, I’ve cherished and held dear every interaction with anyone who reached out to me (or me them) via the blog and would greatly hope to keep in touch with all of you going forward (despite the status of the blog).

If there was one thing I had to end to with, it would be to say that your support, emails and visits to this blog have been and will continue to be greatly appreciated, so much more than words can describe.

Thank you for the allowing and inspiring me and this blog to be a part of your routine and here’s hoping I can return soon.

In the meantime, I can be reached via the contact us tab at the top of this page or at arjun [at] investingthesis [dot] com

Best wishes to you all and may you have a smashing time,

Arjun

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Setting aside the current unrest in Libya for a moment, the fact remains that Africa presents a wealth of opportunity and growth for companies and investors. For resource companies in particular, the bounty of riches is there for the taking. Companies like Redback Mining (acquired by Kinross), Semafo, Teranga Gold, Keegan Resources among others are all examples of Canadian companies that have ventured into the African continent and met with success. However, despite these successes a number of factors, be they political, economic or cultural, a number of investors in Canada have this built up this invisible wall of fear about African resource companies, which may or may not be justified. To find out if these fears really are valid or not, I turned to Michael Cooper, CFa an analyst at Cooper Financial Research, who has spent a lot of time delving into the politics, economics and most of all, investment opportunities in the Democratic Republic of Congo (DRC).

Disclosure: I have positions in both Kinross & Keegan Resources.

Enjoy.

Michael Cooper, CFA

Q: Mr. Cooper, why don’t you start by telling us what led you to your current role and inspired your interest in researching and analyzing gold mining companies in Africa?

A: My role with Banro Corporation (BAA:TSX) and Loncor Resources (LN:TSX-V) originated from a long-term search for undervalued stocks. Mineral resources have been in an upswing and I have been searching for assets that are well positioned to benefit from high price levels. The range of prices for mineral resources in the ground is surprisingly high. In historically troubled geographies such as many countries on the African continent, resources can still be purchased for very low prices. However, what really excited me was the potential throughout Africa for improvement of its economies and politics. In the summer of 2010, the CFA European Investment Conference published one conclusion that sealed my interest in the potential improvements in Africa. The conference speakers, including Nouriel Roubini highlighted that Africa could be the next investment frontier. With this inspiration, I started my investigation and became very excited by the possibilities for the African continent. Africa occupies a huge land mass and is very diverse with 53 countries, and growing, with the new Southern Sudan, and more than 2,000 languages spoken on the continent. Obviously with this heterogeneity, there are many opportunities to spot positive and negative changes in investment conditions. My search led me to the Democratic Republic of Congo (‘DRC’) as the go-to country. The DRC has massive endowments of natural resources and resource potential that has yet to be tapped. And most importantly, the government, although slower than many would like, is making important strides in improving the investment conditions in the country. The DRC is on the verge of signing a regional free trade agreement with its neighbors. This COMESA free trade agreement represents an important step toward more regional integration and stability. Also, the DRC has taken important steps toward joining the 16 country Organization for Harmonization of Business Law in Africa that will strengthen DRC’s rule of law and improve conditions for all investors in the DRC. These are critical steps toward improving investing conditions in the country, lowering risks and increasing asset values. One strong signal that this is working is the recent ratification of a $6 billion investment by China that will lead to the rapid build-out of thousands of kilometers of roads, new sewer systems, medical facilities and hydro electric facilities. We expect that the future will continue to include some unpleasant surprises however the trend is toward overall improvements in the investment environment.

Q: What is your reading on the perceptions of Canadian investors in Democratic Republic of the Congo and the valuations and multiples they are willing to pay for projects in the DRC as opposed to Johannesburg or even Ghana?

A: DRC has experienced a traumatic history since independence in 1960. This is what the majority of Canadian and American investors consider first when they think DRC. However, essentially everyone also understands that this is elephant gold country in addition to being extremely well endowed with other resources such as oil, copper, tin, cobalt and hydro development potential. And now, with some of the improvements in the DRC, people are rethinking the return potential and risks. DRC has been rated as one of the most improved countries in Africa, albeit up from last place, in terms of governance and economic development. These improvements are increasing investor interest in DRC. At the Indaba conference (a pan-African investment conference) held in early February, DRC was referred to as one of the most compelling countries for investors. This is an encouraging development among those of us who are working and investing in Africa.

With regard to valuations and multiples compared to some other countries in Africa, such as South Africa or Ghana, DRC assets are cheaper but perhaps growing more quickly than some of the more developed countries. Each of the African countries has its own set of issues and opportunities. It is difficult and perhaps somewhat misleading to view Africa as a homogeneous investment region. DRC multiples are very low. As an example, in our index of 16 companies operating in various countries throughout Africa, the average value per oz of gold in the ground, in the measured, indicated and inferred category, is $770 whereas Banro Corporation, which goes into production in Q4 ‘11 is trading in the $400 per oz range. (We add cash cost per oz and market cap per oz to determine value per oz). Gold values for investors in South African operations have relatively high and growing extraction costs as their miners dig deeper and encounter lower grades of gold.

Q: Are these perceptions on the part on Canadians justified?

A: We are seeing a change in Canadian perceptions of Africa in general and the DRC specifically. Investor conclusions about the potential of this region tend to improve with more knowledge and understanding of the current situation and future prospects. Therefore, I would say that initial superficial perceptions are increasingly less justified, however, upon investigation perceptions tend to align with a more optimistic outlook. We believe, we are on the cusp of a major global recognition of the value of the DRC. Over the next decade we expect strong improvements in infrastructure development, mineral exploration and development, and financial capacity of the people and their resources.

Q: To dig a little further what are some of the challenges (in terms of politics or permitting or electricity or labour/unions etc.) faced by Canadian resource companies working in Africa, especially countries like the Democratic Republic of the Congo. Most people have a fear of the unknown and if you can go into detail about the some of the problems then perhaps some of the ‘unknown’ doesn’t remain that way.

A: I think you have hit on the main points of fear and risk in Africa. Africa is a continent for long term investors. These are the investors that will be exceptionally well rewarded. We segment Africa into 3 regions; north, central and south. North Africa or the Islamic component has their own set of problems which are well exposed. Central Africa is the underdeveloped portion that is so well endowed with untapped resources. Here we have a lack of infrastructure however, with the new government efforts to strengthen their rule of law and a dramatic increase in infrastructure investment, things are changing. We now have major companies from around the world investing in oil exploration and development, hydro projects, mining projects, road and other infrastructure development. China is one of the major investors in Africa and we expect their long term investment philosophy will increasingly result in additional new infrastructure development. Even financing and insurance costs are decreasing and accessibility of financing is improving. These were major hurdles to development in the recent past.

Q: Having talked about the challenges of mining in the DRC, I would like to turn our attention to the potential and opportunities that the DRC has to offer. Both Loncor and Banro, two companies that you cover have focused their efforts in the DRC – why is that? In terms of geology, what makes the DRC such a great place to be exploring for gold?

A: I am not a geologist, however I have read and continue to read everything I can get my hands on regarding the geology of this region. I have not heard anyone dispute the attractiveness of the geology of this region. Much of the previously discovered gold in Africa has been found in South Africa as well as the Birimian Greenstone Belt which centers on western Africa and has resulted in the discovery of over 200 million oz of gold resources, and counting. This greenstone belt has rewarded Ghana, Senegal, Ivory Coast, Burkina Faso and other Western African nations and pulled many people out of poverty. More recently, the discovery of vast tracks of greenstone belts around the Lake Victoria region has resulted in, arguably, one of the fastest growing greenstone belts in the world. This region has spawned world class gold deposits including African Barrick Corporation’s (LON:ABG) Bulyanhulu 15 million oz deposit, the Buswagi 5 million oz deposit and AngloGold Ashanti’s Geita 17 million oz gold mine. This geology in Tanzania is similar to the greenstone belts in N.E. DRC where Loncor Resources (TSX-V:LN)(PINK:LNRFF) and Kilo Goldmines Ltd. (TSX-V:KGL) and Randgold Resources Ltd. (Nasdaq:GOLD) are exploring. Newmont Mining of Canada also has a stake in this region through its Loncor investment. Because of the historical political situation, these large greenstone belts had been unexplored. Now with the improvements in the DRC, we believe this will become a hotbed of exploration and development activity.

Q: Banro has delineated 11.2 million oz. of gold resources (including inferred) in four deposits along the Twangiza-Namoya gold belt and is fully financed for development of Phase 1 of Twangiza with construction expected to be completed in Q3/2011 and production to begin in Q4/2011. Given this backdrop, Mr. Cooper, can you elaborate on the more salient points about the company that we missed? What are your thoughts on the company’s current valuation? When do you see the company get re-rated as it turns into a gold producer and at that point where do you see the stock trading?

A: The company is trading at 30% to 50% of its intrinsic value in my opinion. Banro is now less than 7 months from production. I believe a revaluation process is inevitable imminently. There is little choice for this stock but to move substantially higher over the next 12 months. Banro should produce $0.60 per share in cash flow in its first full year of operation. That on a share price of less than $3.50. Therefore I strongly believe in the steady, or sharp, rise of Banro’s share price.

Some of the complimentary points of the Banro story include the quality and track record of Banro’s management team. Arnold Kondrat founded the company and has led the company through 15 years of challenges to emerge as a successful first mover in the country. Martin Jones heads up the Banro Foundation which ensures that the interests of the local people are being met. Simon Village has a very strong background with leading institutions throughout Africa and Europe. Also, do not forget about the exploration potential. With 210 km of highly prospective land along the Twangiza-Namoya gold belt, Banro could be producing exciting new discovery potential for decades to come. Another major benefit that has come to light with rising oil prices includes the ability to generate inexpensive hydro electric energy in the DRC. The DRC is loaded with mountains, rivers, and plenty of rainfall. These are ideal conditions to generate electricity. The cost of energy is critical for a mining project. At some projects, power can account for 40% of the cash operating costs. By switching from oil and diesel to electricity, Banro’s costs structure could fall from $350 per oz to an estimated $250 per oz. To understand the extent of hydro potential in the DRC, consider the capacity of the Congo River, which is reported to have the ability to increase the world electricity capacity by 13%. This is a staggering figure and points to the attention the DRC will continue to receive in a world that needs clean renewable sources of energy.

Q: Loncor, on the other hand is a much smaller company and still young in its life cycle when compared to Banro. Can you tell us a little more about the company and its prospects?

A: Loncor controls approximately 20,000 sq kilometers of exploration property. The properties are largely Archeaen greenstone belt in the heart of elephant country. These gold regions can stretch for hundreds of kilometers. In Quebec, the Abittibi Archeaen greenstone belt has been under development for 100 years. It has yielded over 130 million oz of gold. Loncor’s Ngayu greenstone belt is unexplored but we are excited by its potential.

Q: What about valuation? How does this company compare to its peers? Also, what does the company’s balance sheet look like? Do you have a target price?

A: I find it difficult to do peer group analysis on exploration companies however, one exploration company with two primary exploration properties and a new acquisition which operates in neighboring Tanzania, is Canaco Resources Inc. (CVE:CAN). Canaco has a market cap of $1 Billion based on some wide intercepts of low grade gold and including some higher grades. However, comparisons can be deceiving. Another peer company is Kilo Goldmines (TSX-V:KGL) which is also exploring the Ngayu greenstone belt, however they do not have the financial resources or management team quality of Loncor so there is some question in the market as to their ability to exploit their land position. Newmont Mining of Canada is an investor in Loncor and they believe, according to their recent investments, that Loncor has significant upside potential.

Q: What catalysts do you see that could move the stock?

A: The single biggest catalyst I see for stocks in the DRC, is the improvement in the legal and political landscape. This is in process with regional integration through the COMESA free trade talks and progress with the Organization for Harmonization of Business Law in Africa. In addition, China’s $6 Billion investment in infrastructure will produce shareholder dividends for those who gain exposure to the DRC early. These are the catalysts that will invite new investment from around the world and start to unlock the substantial value of both Banro and Loncor’s assets. These steps cannot be underestimated as positive developments for the country and the central African region.

In addition we expect to see company specific developments such as drill results from LN from their three to four drill rigs on the property. Also, neighboring drill results such as Kilo Goldmines Ltd. who is also exploring the Ngayu Greenstone belt in the region of LN. Kilo recently announced wide intercepts of gold over 136 meters which highlight some of the potential of this greenstone belt.

Also, we are seeing Rangold increase its activities in the DRC as well as Glencore International AG, Anvil Mining Ltd. (TSX:AVM), Katanga Mining Ltd. (TSX:KAT) and Lundin Mining Corp. (TSX:LUN). Of particular note is Ivanplat’s potential IPO this year. Ivanplat is led by Robert Friedland with a major copper discovery in the DRC.

The other activity to watch is the progress of elections. 17 African elections are expected in 2011. Some such as Uganda have proceeded relatively smoothly while countries in North Africa are not proceeding smoothly.

Q: What is your opinion of Loncor’s management? Lastly, what are some potential risks associated with this stock that could hamper your investment thesis?

A: Loncor’s president is Peter Cowley. Peter has impeccable credentials and a successful track record. Peter was credited with the Geita deposit in Tanzania which is a 17 million oz deposit now being developed by AngloGold Ashanti Limited (NYSE:AU). Peter was also head of Ashanti Gold which merged with Anglo Gold to become one of the leading gold companies in the world with a focus on Africa. The high profile management team is complimented with a exploration team of talented and dedicated North Americans, Europeans and Congolese engineers and explorers.

The risks to both of these stocks include political risk, however, I believe these risks are fully priced into the stock and as mentioned previously, these risks are abating rapidly now. Large investors must also keep liquidity issues in mind.

Thank You, Mr. Cooper!

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Canadian Personal Finance & Investing Carnival

Welcome to the 16th edition of the Canadian Personal Finance & Investing.

Before I continue, I wanted to let all of you know that this will be the last Carnival for the near future. I’m hoping to publish one more post before putting Investing Thesis on temporary hiatus.

Circumstances (good ones) at work have compelled this decision but the good news is that the blog is only on hiatus temporarily. I will be back.

Working (even though it didn’t really feel like work most times) on this blog and interacting with numerous interesting, smart and wonderful readers, portfolio managers, analysts and fellow blogging buddies has enriched my life beyond words and I can’t be more grateful for the experience.

I’d just like to take a second to say thank you to everyone who has communicated with me in connection with this blog.

Before things get too mushy, let’s begin the Canadian Personal Finance & Investing #16.

Canadian Finance Blog presents History of the Canadian Dollar, saying, “The history of the Canadian dollar is almost as interesting as the history of Canada itself. Let’s take a look at the history of the Canadian dollar.”

Canajun Finances presents Inflation Steadies in January, saying, “Inflation steadied for now, but with the Gas price explosion, how long will this last, and it is still 1 full basis point up from last year’s rate at this time.”

Balance Junkie presents RRSP vs. TFSA: One Last Dip into the Debate, saying, “Each of us needs to educate ourselves on both TFSAs and RRSPs and choose the combination that works best for us.”

In Search Of Salt presents Saving Money with Limit Orders, saying, “If you buy individual stocks for your portfolio, you might be familiar with limit orders. If you aren’t familiar with limit orders, you should be, as they are a great tool to ensure that you don’t pay too much, and can also be used to save money.”

Retire Happy Blog presents Are Your GICs Insured Under CDIC?, saying, “Billions of dollars in Canada are invested in safe guaranteed investments like GICs. One of the most attractive features of the GIC is the safety of the capital.”

Million Dollar Journey presents Identifying All Star Fund Managers II – Finding the All Stars, saying, “In the last article, we looked at the first step in identifying All Star Fund Managers – getting rid of the bottom 90% of fund managers/investors. This article is about the final 3 steps in the process that take us from the top 10% to a team of All Star Fund Managers.”

Boomer and Echo presents How To Get The Most Out Of Your Savings, saying, “You need to spend some time figuring out effective ways to get the most out of your savings. Here is a “back-to-basics” primer.”

Money Smarts Blog presents RRSP Home Buyers Plan – First Time Home Buyers Loan, saying, “The RRSP home buyers plan is a great way to beef up your house down payment. When I bought my first house, I had a down payment of $20,000 which was taken from my RRSP. If you are thinking of borrowing from your RRSP to buy a house or condo, here are some rules to know.”

Canadian Capitalist presents New withholding taxes on stock option benefits, saying, “If you receive employee stock options (ESOP) or restricted stock units (RSU) at work or participate in the Employee Stock Purchase Plan (ESPP) offered by your employer, you should be aware of new CRA rules on withholding taxes.”

Young & Thrifty presents Vietnam Travel on the Cheap (Especially During Tet)

Financial Highway presents Deferral of RRSP income: A Great Tax Strategy . . .But, saying, “When it comes to money and personal finance, this time of year gets people thinking about tax and RRSPs (Registered Retirement Savings Plan). When you buy your RRSPs, we often get focused on the tax deduction and forget the benefits of future tax deferral.”

Beating The Index presents Investing in Oil: My Bias for Canadian Oil Producers, saying, “The recent events in the Middle East and North Africa clearly justify my shameless bias towards Canadian oil producers. Yes oil is a global resource when it comes to supply and demand so why concentrate only on domestic producers when there’s so much exploration and production going on all over world?”

Invest It Wisely presents Lessons Learned from Moving Out at a Young Age, saying, “Moving into my first apartment nearly 8 years ago was no big deal. Just about all of my furniture were hand-me-downs from family or stuff I was bringing along, and when moving into an apartment there isn’t too much else to take care of since first, you’re not expecting everything to be perfect, and two, much of that stuff is someone else’s responsibility.”

Investing Thesis presents An Energy Pick By Portfolio Manager Daniel Cheng of Matco Financial Energy Fund

Rob Carrick presents Guaranteed retirement income, but at a price, saying, “The life annuity is a retirement investing product with to-die-for optics.”

Martin Mittelstaedt presents Private equity fund shines in spotting takeover deals, saying, “Sentient Group has an uncanny knack for owning takeover candidates in the highly speculative junior resource sector.”

Jonathan Chevreau presents Read between the literacy lines, saying, “The noble goal of boosting financial literacy is like motherhood or apple pie: You won’t find many bad-mouthing it. So it was predictable that Canada’s financial industry fell over itself this week to praise the final report of the Financial Literacy Task Force.”

Larry MacDonald presents More on where invest your RRSP, saying, “As the RRSP season comes to an end, many people are engaged in the last-minute rush to make a contribution. Others may have already contributed but the money is just sitting there as cash until they decide where they want to invest it. Let’s look at some ideas.”

Canadian Couch Potato presents How Often Should You Rebalance?, saying, “In my previous post, I looked at the reasons why investors should occasionally rebalance their portfolios. When a portfolio contains both fixed-income and equities, rebalancing is mostly about risk management: if it also results in higher returns, that’s a secondary benefit. Having a disciplined rebalancing schedule also helps you control your behaviour and resist the pressure to chase performance.”

Lastly, if you haven’t already subscribed to InvestingThesis.com, allow me to reiterate a few reasons to do so:

1. You never have to check the site for updates again, and you get the latest and greatest first.
2. It’s totally free.
3. Your info will never be shared with anyone. Never. Ever. I hate spammers as much as you do.
4. Subscribing is worth testing for a few days just to experience it. Decide you prefer visiting? Just unsubscribe with one click and it’s happy times again.
5. Subscribers are smart and cool.

That’s a wrap, folks! Have a smashing day and week!

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Following up on the interview with Daniel Cheng of Matco Financial, I now present one of Daniel’s top picks in the energy sector.

Enjoy.

Daniel Cheng, CFA is Vice President and Portfolio Manager at Matco Financial

Q: Can you tell us a little bit about the company, the economics of the industry/sector and anything else you think is important to get an overview of the company?

A: Blackpearl Resources (PXX:TSX) is currently one of the largest holdings in the MFi Energy Fund and we purchased it in early 2009. One of the main reasons that I like this company and have liked this company is that there are basically only a handful of oil weighted junior and intermediate companies in Canada and they are one of them. They are a heavy oil focused company with both conventional heavy oil as well as SAGD potential. The company has three core properties, Mooney, Onion Lake and Blackrod of which they have high working interest in all and are the operator of all three. The companies production is 95% weighted to oil, which given current oil prices is a great place to be. Heavy oil differentials have narrowed dramatically over the past two years due to a number of factors including increased refinery demand for heavier barrels, increased access to key refining markets and decreased production from Venezuela and Mexico and I expect that this differential will remain tighter than historical in the medium term (~15-20%). Current production is over 7,000 boe/d and they are looking to reach 11,000 – 13,000 boe/d by the end of 2011 and ultimately be producing more than 50,000 boe/d+. Production growth is expected to be >35% this year and production per share growth >35%. They have a high working interest in their three core properties and very large resource potential (739 mmboe of contingent resource) on their properties to support their future growth plans. At Onion Lake they are drilling more than 200 wells over the next few years for primary development and longer term SAGD potential exists which would increase recovery factors. At Mooney they are working on commercialization of a polymer flood which they received approval for last year. The Blackrod property has the largest future potential (619 mmboe of contingent resource) for the company through a SAGD project. There is no current production from the area and they are drilling the first pilot well pair here and will begin steaming in the next few months.

Q: What about valuation? How does this company compare to its peers? Also, what does the company’s balance sheet look like? Do you have a target price?

A: With respect to valuation, Blackpearl currently trades at the upper end of valuation metrics on all conventional metrics compared to its peers at ~17x 2011 EV/DACF and ~10x 2012 EV/DACF vs. the mid cap average of 11.1x 2011 EV/DACF and 8.0x 2012 EV/DACF. However, there are very few true peers to Blackpearl in terms of production mix, market cap etc. so it is difficult to do a broad peer analysis. Many gas weighted intermediate companies are actually trading at similar valuation metrics to PXX, which is difficult to justify I believe given where gas prices are compared to oil. With respect to the oil sands comparables, many of them don’t currently have any production and associated cash flow or earnings so conventional metrics are difficult to apply here as well. But as discussed above, the metrics that we look at when investing focus on the underlying asset value and go forward net asset value of the companies resource and future production profile. In the case of Blackpearl when we made our investment the company was trading well below its net asset value and was trading at 5.0x EV/DACF. We continue to think the company is trading under its go forward net asset value based on the its resource potential in the ground which we believe is in the $10 range with room for upside based on deliverability and continued delineation. I believe Blackpearl will be able to trade at a premium valuation given the visibility on its production profile and long life resource base. Lastly, another reason I like this company is that they have no debt, so positive working capital which is definitely not the norm for a junior/mid cap energy company. They are self funding which eliminates a key risk factor that has hampered many energy companies.

Q: What catalysts do you see that could move the stock?

A: The company has a material resource and the business plan is to increase production on its core properties and prove up its resource base with continued delineation drilling. This is something that I like, a more measured approach to development as opposed to potentially binary outcomes of some exploration companies so it offers diversification from that perspective. Catalysts for the stock going forward here include higher oil prices, improved recoveries, results from the first phase of its polymer flood at Mooney beginning in Q2 and results from the drilling program at Onion Lake this year which could lead to resource estimates being revised upwards. They also received regulatory approval for their pilot at Blackrod with first steam injection planned for March of this year and results from the pilot expected early next year. Plans are to file a commercial development application in early 2012. The company is expecting to grow production to 11,000 – 13,000 boe/d by the end of the year, up from 8,000 boe/d at the end of 2010.

Q: What is your opinion of the company’s management, Dan? How have they performed leading up to this point? Have they delivered on their promises? Do they have prior experience running a company like this?

A: Blackpearl is run by a very experienced management team lead by Mr. John Festival and senior executives who previously ran Blackrock Ventures. Blackpearl in its current state was created in early 2009 with the acquisition of BlackCore Resources which brought Mr. Festival and his team. Blackrock, managements previous company was another heavy oil focused junior producing in the Seal area of Alberta. The management team grew production from 0 to 16,000 boe/d and reserves from 11 mmb to 195 mmb in roughly three years and BlackRock was ultimately sold to Shell in 2006 for $2.4 billion cash. Blackpearl is a very similar company to BlackRock given its heavy oil focus, large resource in place and longer term development plan. Management has executed their plan well delineating and proving up their resource base and taking their core properties to commercial scale development all while maintaining a conservative financial position. In 2010 they exceeded our production estimates and hit the expected exit rate of 8,000 boe/d. Management also owns ~10% of the shares outstanding.

Q: Lastly, what are some potential risks associated with this stock that could hamper your investment thesis?

A: If oil prices were to fall dramatically, which I don’t forsee happening at this point, Blackpearl will trade lower given its 95% weighting to oil production. If heavy oil differentials were to widen dramatically they would also be impacted given their exposure to heavy oil. As with all energy companies, ultimately well performance and capital efficiencies are also potential risks. Other risks would be related to regulatory issues or timing delays for its projects that would impact the realization of its production.

Thank You, Daniel!

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This post was included in the Carnival of Money Stories, Totally Money Blog Carnival, Carnival of Wealth and the Canadian Finance Carnival.

With the crude contract for March rising by 72 cents to $85.04 U.S. on the back of news claiming a lesser build in inventories by the U.S. Energy Information Administration, the focus is back on the energy sector. Adding more fuel to the fire (pun intended) was news about Iran sending warships through Egypt’s Suez Canal en route to Syria for the first time in years has elicited comments from Israel’s foreign minister calling it another of Iran’s “provocations.”

Daniel Cheng, CFA is Vice President and Portfolio Manager at Matco Financial

Biography: Daniel Cheng, CFA is Vice President and Portfolio Manager at Matco Financial. Mr. Cheng is a member of the Matco investment committee. He is also a member of Matco’s Canadian Equity Group, which is responsible for the Canadian Equity, Small Cap, and Energy Portfolios. Mr. Cheng was formerly with Ross Smith Energy Group, an energy research firm. He was also a member of the institutional equity research group with Tristone Capital Inc.

Q: What are your thoughts on crude oil for the next 6 months? What price assumptions are you using in your models for earnings and cash flow analysis for 2011 and beyond?

A: I have been constructive on oil prices for the past year and continue to be quite bullish looking ahead in 2011. The fundamentals for oil continue to improve as the global economy recovers with global demand now expected to cross 89 mmb/d in 2011, after reaching a record high in 2010 and completing arguably one of the strongest post recession recoveries for oil demand. Not surprisingly, the recovery in demand was driven entirely by non-OECD countries lead by China. Demand growth remains from the emerging economies going forward and they are expected to account for more than 50% of global demand within the next two years.

Some interesting statistics on China: China currently consumes one of the lowest levels of oil consumption per capita in the world despite the robust growth of late. On a per capita basis, China consumes approximately 2.5 barrels of oil per person per year. Contrast this to the United States which consumes closer to 23 barrels of oil per person each year. I am not saying that China will ever get to the same level of demand as the US, but as incomes continue to rise in China you should see a corresponding increase in oil demand. As well, a lot was made about China surpassing the US in terms of vehicle sales in 2009 but 2010 saw continued robust growth (30%+) in vehicle sales in China. Despite the rapid growth in sales, vehicle penetration in China remains very low at approximately 40 cars per 1,000 people compared to an average of 673 cars for the G7 nations. This increase in vehicles on the road is driving strong transportation fuel demand, one of the primary drivers of global oil demand. So for oil prices, these are the longer term supporters I see.

Shorter term, inventory levels have seen a fairly steady decline over the past year including floating storage levels which has also tightened the supply demand balance. Geopolitical issues such as what is happening in Egypt currently also pose short term upside risk to prices but I think oil prices likely trade in a range of $85-$95/b in 2011. So, longer term I am still bullish. In the next six months could you see oil prices pull back? Absolutely, but I believe they will be temporary pullbacks in a structurally bullish oil price environment. We are long term investors so we continue to be overweight oil producers in our portfolios.

In our modeling we run strip pricing for the first two years and are now running flat $90 long term oil prices after that. However, we always run scenario analysis on a wide range of commodity prices to see the impact on net asset values for the company before making an investment.

Q: When commodities are experiencing a tailwind as in the case of crude oil in 2010, ‘stock picking’ becomes increasingly crucial as valuations on a broad basis tend to inflate. What are the metrics or factors that you look at or use to determine the value of a junior/mid-cap crude oil producer?

A: It is true that stock picking becomes more important, however for resource based companies like oil and gas, higher commodity prices should translate into stronger cash flow and often better valuations depending on what kind of commodity price you are using to run your models. The metrics that I like to focus on when determining the value of a junior/mid-cap producer are related to the assets that they possess and the cash flow that those assets will be able to generate. Production growth and how efficiently the company can generate that production growth is another important factor we asses. Price to net asset value is a core metric that we focus on and a calculated upside net asset value based on the companies prospect inventory. In addition to that, we monitor the more traditional metrics when looking at energy stocks as a barometer of the relative valuation to the peer group and historical metrics we are paying for the company such as enterprise value to debt adjusted cash flow (EV/DACF), enterprise value per flowing barrel a day of production (EV/BOE/D) and enterprise value to barrels of oil equivalent of reserves (EV/BOE). The other key metrics we look at are related to the balance sheet. Debt to cash flow and the amount of debt in general is important to us especially after what happened in 2008 and 2009 when many junior and mid cap energy companies were crushed by their debt load.

Q: It seems that each year brings a new and prolific oil trend or area play, how do you go about evaluating the potential of these plays (why were they not discovered before?) and what is your strategy when it comes to picking stocks in these plays – do you invest in the first mover, derivative plays etc.

A: When we come across a new play, or more likely an older play that has really been unlocked as a result of technical innovation (Cardium for example) it starts a rigorous process. We have a unique relationship with the Ross Smith Energy Group (North Americas leading independent energy research firm) who provides us with in depth technical analysis of the plays from a geological and engineering perspective. They have evaluated almost every play in North America over the past decade and as mentioned, many of the so called “new” plays have been around for a long time but are now being exploited with the application of new technology that didn’t exist previously such as horizontal multi stage, hydraulic fracturing. For true new plays it is even more important to understand the geological profile of the play and how it compares in relation to other plays to understand the viability and ultimate deliverability of that play. There are many plays out there that undoubtedly contain a vast amount of resource but the cost to produce that resource and required commodity price to make the economics work often don’t line up.

When picking companies in certain plays we like companies who are not necessarily the first mover though this is often the case but companies that have the most meaningful exposure to the play and are in what we would deem as the sweet spot of the play. Variability of results in a play can be very dramatic depending on the land position and you are seeing this materialize in a number of resource type plays. Break even prices within the same play can be vastly different as evidenced by the chart below. The Cardium for example is seeing break even prices below $50/b in some areas to over $100/b in other areas of the play. We are also cognizant of how the company entered the play as with a lot of the “hot” plays, land prices can heat up very quickly and the cost for the acreage rises dramatically altering the economics dramatically. The MFi Energy Fund has a bias to small and mid cap producers and generally speaking, these are the companies that have the greatest relative exposure to a play.

Break Even Crude Price For Wells Drilled In Different Crude Oil Plays - Courtesy Ross Smith Energy Group

Q: What are your thoughts on natural gas for the next 6 months? What price assumptions are you using in your models for earnings and cash flow analysis for 2011 and beyond?

A: Natural gas continues to face challenging headwinds in my opinion and I don’t foresee them improving in the short term. As I mentioned with oil really being a story of demand, natural gas continues to be a story of robust supply. The application of horizontal multistage fracturing has really opened up a vast amount of resources in North America and natural gas in particular here is a continental product unlike oil. The rig count in the US has remained stubbornly high in light of where natural gas prices are and the focus remains on the more prolific plays. In addition, natural gas storage levels are still elevated and on top of that I have seen estimates as high as 3,000 wells that have been drilled in the US and are just waiting to be tied in. So if natural gas prices find any sort of strength, you have the ability to see a lot of gas come back to market quickly which will keep a lid on prices going much higher. There are a number of reasons that producers have continued drilling through the weak prices and that relates to land retention issues south of the border, strong hedge books and joint ventures with international companies that have a different mandate and essentially unlimited capital. On the demand side the growth is just not strong enough to offset the supply growth currently and weather related demand hasn’t moved the needle much either given we have had a very cold winter thus far. That being said, I do think that natural gas prices will move higher at some point in time as the vast majority of natural gas plays are not economic at current prices.

Price assumptions we are using in our modeling is the same as for oil with strip pricing the first two years and then flat $4.50 after that.

Q: Given your challenged outlook on natural gas and assuming valuations on the downside often find a floor at or slightly above long run F&D costs, what are your thoughts on rotating into some natural gas producers, especially those that are making money at depressed natural gas prices? Is this something you might do or are possibly doing now?

A: I think it is still a bit premature to rotate into natural gas weighted companies in a meaningful way. As mentioned previously, I agree that longer term gas prices likely need to be higher than where they are but likely that won’t happen until the latter part of this year at the earliest. We do own natural gas weighted companies and I think that you can still make money investing in natural gas companies but you must be selective. We have maintained exposure to a number of natural gas companies operating in some of the lowest cost plays in North America and companies that are also drilling liquids rich natural gas. A lot of companies that have oil production or liquids rich targets are now focusing all of their capital in those plays and have essentially abandoned drilling for natural gas in the current price environment. We have not added to our natural gas exposure recently.

Q: Can you talk a little bit about liquids rich natural gas and maybe how it’s similar or different from regular natural gas?

A: Generally speaking, liquids-rich gas is natural gas that also has some heavier hydrocarbon components separated out as liquids, which are referred to as natural gas liquids. Natural gas liquids—used in the petrochemical industry and as diluent for blending heavier crude oil grades and as fuels such as ethane, propane, and butane are more valuable than natural gas as they typically trade in relation to oil prices. This has become a focus of many producers who may not have oil assets as they seek to drill the most economic wells given the large disparity between oil and gas prices. Some liquids rich natural gas plays offer better economics than many oil plays.

Q: What are some of the area plays (domestic or international) that you are investing in and/or keeping an eye on?

A: There are quite a few plays we are invested in and are keeping an eye on currently including the Cardium, Bakken, Alberta Bakken (Exshaw), Eagleford, Red Earth Slave Point, Viking, Swan Hills, and Sprayberry to name a few. We also still have a number of natural gas focused investments in various plays such as the Montney and Haynesville and are watching number of plays that are in their infancy such as the Duvernay. I really believe that we are in a new era for the oil and gas industry and in the Western Canadian Sedimentary Basin with the drilling and completion technology that continues to evolve and improve. It’s a technological revolution in the industry that is opening up previously uneconomic plays. Additionally, we are also looking at a number of international areas including Columbia, Egypt and Australia.

Q: What would make you shift your weighting and outlook from crude oil to natural gas?

A: A significant reduction in the rig count south of the border. I think some meaningful reductions in natural gas directed capital expenditures from the producers will lead this and you are beginning to see this happen. Additionally, the end of land retention drilling will further support this and the rolling over of hedge books. Until there is a clearer picture on the supply front for natural gas, my bias remains towards oil.

Thank You Mr. Cheng!

[Note: Stay tuned for Mr. Cheng's largest energy holding and pick early next week.]

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I’ve been trying to study for an exam (capital markets related) that I write in a few weeks and find myself racing against time. However, I enjoy putting together the Canadian Personal Finance & Investing too much to neglect and thus I present, edition number 15.

22 articles have been highlighted and my hope is that you enjoy each and every one. Mind you, it will probably take you at least a couple of hours to get through them all but consider it an investment in yourself and the time will fly by.

These next few lines are directed to all you Canadian Personal Finance & Investing bloggers out there. While we have your attention, we would like to take this moment to invite submissions for the 16th edition of the Canadian Personal Finance & Investing Carnival slated for publishing on February 28th, 2011. So if you’re a Canadian blogger specializing in personal finance and or investing, make sure you submit your best articles for inclusion and while you’re at it, perhaps spread the word about the Canadian Personal Finance & Investing Carnival.

And now, begins the Carnival.

Boomer and Echo presents How To Invest Your Money: Part Four – Building Your Portfolio, saying, “This is the final part of a four part series on how to invest your money. The main focus of this series of articles is to discuss the psychology of investing, how to get started, finding your strategy, and building your portfolio.”

Balance Junkie presents PIMCO’s Battle Call to Bond Vigilantes, saying, “It sounds like PIMCO is ready to fight the Fed by selling Treasuries. This could have broad implications for interest rates, bond prices and eventually, the stock market.”

Sustainable Personal Finance presents Are Investing Experts Ethical?, saying, “Given the inherent nature of their profession how to investing experts remain ethical?”

Canajun Finances presents Top 10 Bad Financial Lists, saying, “Top 10 lists that I really hope are never published.”

Canadian Finance Blog presents RRSP Basics: RRSP Contribution and RRSP Withdrawal, saying, “The RRSP deadline is coming up soon. Before you make a RRSP contribution or RRSP withdrawal, here are some RRSP basics you need to know.”

Retire Happy Blog presents Top Timeless Tax Tips, saying, “As the tax filing deadline looms, we are all trying our hardest to pay as little tax as possible. So this time of year, it’s pretty common to find different experts sharing their top tax savings tips.”

Million Dollar Journey presents A Primer on Exchange-Traded Fund (ETF) Terminology, saying, “An ETF is a well-known investment vehicle these days; usually, they closely track an index – be it sector or asset class – by holding the same basket of stocks or bonds similar to index (mutual) funds.”

Canadian Couch Potato presents BMO’s Target Maturity Corporate Bond Funds, saying, “One of the criticisms of bond funds is that they have no maturity date. If you buy an individual 10-year bond, you know you’ll collect fixed interest payments twice a year, and you know you’ll receive the face value of the bond when it matures in a decade. But if you invest in a bond fund, you can’t be sure what its value will be in 10 years. That uncertainty can make financial planning more difficult.”

Larry MacDonald presents What to do with your RRSP, saying, “Wondering what to do with your RRSP? You can read articles in the press or visit a financial advisor. For a change of pace, let’s look at what other individuals are doing with their RRSPs. Perhaps their examples can provide some ideas.”

Canadian Capitalist presents Will Better Fee Disclosure Help?, saying, “You would expect that if investors were made aware of how much fees they were paying, they would wise up and choose low cost investments. Unfortunately, that doesn’t seem to be case.”

Finance Fox presents HOW DO YOU TRACK YOUR MONEY?, saying, “When it comes to money management, there are a number of ways to go about it. Financial institutions send us monthly statements, you can print all your account statements online, various software, Excel Spreadsheets, online money management websites (think Mint.ca) and of course the good old traditional way, paper & pen, you keep track of your own money. I have two systems, that work well for me and keep track of my money. They’ve worked well for me, over the past months or ever since I truly got serious about eliminating my debt.”

Invest It Wisely presents 3 Reasons to Add Dividend Stocks to Your Portfolio, saying, “25 years ago, dividend investing was considered a fundamental part of every investor’s portfolio. Investors received a portion of a corporation’s profit as a “dividend” (or return) on their investment. Companies that paid a dividend were financially stable “widow-and-orphan” investments.”

Beating The Index presents The Alberta Bakken Oil Play, saying, “The Bakken formation is a 350 million-year-old layer of rock occupying 520,000 km2 of the subsurface of the Williston Basin covering parts of Saskatchewan, Manitoba, North Dakota and Western Montana. The formation was discovered in 1953 and as early as 1974, it was postulated that vast amounts of petroleum (up to 500 billion barrels) were contained in the formation itself but it was not economically viable as the oil was trapped in shale (fine sedimentary rocks).”

Financial Highway presents You Are Not The Stocks You Invest In, saying, “Do you identify with the stocks that you choose to invest in? Doing so can be detrimental to your financial health. And if you think that you don’t, you might want to think again. That’s because many people feel an emotional connection with their stock investments and don’t even realize it.”

Investing Thesis presents On A Quest To Turn $3000 Into $100000 With Trader Mark Li, DMS

In Search Of Salt presents Obtaining Your Canadian Credit Score, saying, “Long time readers will know that I request a free credit report by mail in about June, and pay for my online credit report and score in December of each year.”

Money Smarts Blog presents How To Run A Background Check On Your Canadian Financial Advisor, saying, “Before you hire a financial advisor, it is important to do some research and make sure the advisor is who they say they are. Did they really complete their CFP? Are they licensed in your province? Have there been disciplinary action against them in the past? Just because a potential financial advisor wears a nice suit, doesn’t mean they are legit. To complete a background check on an advisor, you only need their name. The company name they are licensed to deal with is also useful.”

Rob Carrick presents Look to ETFs to hedge against rising rates, saying, “Look to exchange-traded funds if you need a way to protect the bond side of your portfolio from the threat of rising interest rates.”

Dianne Maley presents How specialty funds can spice up a portfolio, saying, “Even conservative investors can enhance their portfolios with a dash of global stocks, a spoonful of alternative strategies or a pinch of high-yield bonds – albeit with some risk.”

Jonathan Chevreau presents Retire early: It might actually save you money, saying, “If you are worried about stretching your dollars and minimizing the tax hit at retirement, there are two ways you can “melt down” RRSPs before they become highly taxed RRIFs or trigger clawbacks of Old Age Security.”

Divestor presents Financial Literacy, saying, “The government of Canada commissioned a task force to study the issue of financial literacy in Canada. I will restrain my comments to say that just as how (in Western Europe) illiteracy was reduced from about 2/3rds in the 18th century to less than 10% today, I would estimate the financial literacy of Canada as being quite low.”

Moneyville presents 9 ways to earn cash in your spare time, saying, “For as long as I can remember, I’ve tried to think of clever ways to come up with extra money. At first, it was to pay down debt. Now, it is to save for retirement, and for my first home. Here are nine interesting ways to make money, without having a set time commitment – perfect for those who are too busy for a part-time job!”

Lastly, if you haven’t already subscribed to InvestingThesis.com, allow me to reiterate a few reasons to do so:

1. You never have to check the site for updates again, and you get the latest and greatest first.
2. It’s totally free.
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5. Subscribers are smart and cool.

That’s a wrap, folks! Have a smashing day and week!

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Hsing-Tsai (Mark) Li is an Investment Specialist at BMO

Note: This interview was carried out on Jan 31, 2011.

Biography: Hsing-Tsai (Mark) Li has been trading currencies and equities for over four years using technical and fundamental analysis as the basis of his trading. He is currently working with the Bank of Montreal as an Investment Specialist. Mark currently holds the Derivatives Market Specialist (DMS) designation and is a CFA Level 2 and CMT Level 2 candidate.

Mark can be found blogging at http://marktekfx.wordpress.com/

Q: Mark, tell us a bit about how you got interested in investing/trading?

A: My interest in investing dates back to 2006, when I came across a Forbes article entitled “The World’s Richest People” which listed Bill Gates as the richest person in the world followed by Warren Buffett. After reading both profiles, I came to a conclusion that I would follow the path of Warren Buffet, the Oracle of Omaha, since in my junior years I was never good at programming and was infatuated with numbers and economics. One of the qualities I liked about Warren Buffett was how he simplified investing and in every interview he spoke in a layman’s language which would be understood by everybody.

Q: How (and from what sources) did you learn technical analysis?

A: Initially I based my investing purely on fundamental analysis. However, over a period of months, I realized even though some of the companies had good fundamentals, I was still buying companies at disadvantageous prices. In 2007, I came across a book by Steve Nison called “Japanese Candlestick Charting Techniques” which led to my interest in technical analysis and helped me improve my decision making skills on what prices to buy or sell an investment. Another book which had an huge impact on my trading is the “Encyclopedia of Chart Patterns” by Thomas N. Bulkowski which contains information on important chart patterns and also the statistics of each pattern’s success and fail rate.

Q: How would you describe your current strategy (in terms of the types of trades you enter, position sizing, the duration you hold) when it comes to trading equities? How much attention do you pay to fundamental analysis?

A: I currently have two types of accounts: one is for short-term trading which involves trades that are closed within the trading day and I also have a long-term account in which trades are left open anywhere from a couple of days to a couple of months depending on when the price target is achieved. For my short-term trading account, position sizing is usually smaller since its easier to get in and out of the market and easier to manage the risk involved with each trade. On the other hand, for my long term accounts, position sizes are usually larger.

Personally, for short term trading, decisions are based purely on technical analysis, since my price targets are smaller whereas for long-term trades, I scan the equities based on technical analysis and then I apply fundamental analysis to determine whether I should buy or sell a particular company.

Q: Can you walk us through how you came to develop your personal strategy?

A: For short term trades, I use candlestick patterns, support and resistance areas also known as regions of interest and technical indicators to determine my entry and exit points and for longer term trends I use only candlestick patterns, support and resistance areas.

Personally to determine which technical indicator works on short time frames, it depends on using different values for a particular technical indicator, for example: some stocks can easily be determined to buy or sell by using 13 day EMA (exponential moving average) on 5 minute time frames, on the other hand the same moving average might not be useful for a different stock or even for a different time frame for the same stock, hence technical indicators would be useful as long as its customized and backtested during different time periods. To backtest a technical indicator for shorter time frames requires a lot more time since it involves evaluating the behavior of a particular stock over extended periods of time, which might involve analyzing upto 20 years of historical price data.

Q: From the plethora of available technical indicators, which ones do you pay most attention to when analyzing equities?

A: For my short-term trading, I use RSI (Relative Strength Index) which simply compares the magnitude of recent gains to recent losses to determine if a particular stock is overbought (potentially time to sell) or oversold (potentially time to buy). I also use moving averages which help in determining the direction of the trend.

Baidu Price Chart

For example in the chart above, I have drawn the rectangular area which is a region of interest i.e. the rectangular region first becomes a support (failure of price to go lower), after which it becomes a consolidation. On Jan 25th at 3:00 pm EST the price falls into this region, forms a bullish candle (price opens lower and closes higher than the previous candle) in the region of interest and RSI (Relative Strength Index) has a crossover of 50 indicating buyers overpowering sellers.

Q: If you do form a technical opinion on the broader markets especially when it comes to equities, what asset classes and indices do you look at? If you strictly focus on specific equities, how do you source or find these ideas (screens, blogs, newsletters etc.)?

A: I focus primarily on individual stocks or securities. To find an idea, I scan through hundred for charts everyday looking for candlestick formations in the support (failure of price to go lower) or resistance (failure of price to go higher) areas. I have two set of watch-lists which I go through every day, one is based on large cap stocks and the second is based on small cap stocks.

Q: Now that we’ve gotten some background on how you trade, Mark, why don’t we transition to some trades ideas that you are looking at. In terms of equities, can you let us in on a trade that you are in or are currently looking at? Perhaps you can talk about what specifically in the price chart makes you want to enter this trade (and what would make you want to exit the trade), your entry, stop loss and exit price?

A: One of the stocks I am currently looking at is Shaw Communications (SRJ.B:TSX) traded on Toronto Stock Exchange as a long term trade. At a current price of $21, for me this would be considered a buy in this region for the following reasons:

Shaw Communications Price Chart

• On weekly chart as in the chart above, the rectangular region between 21.75 and 21.50 has been acting as a region f interest, which means this region has acted as support (failure of price to go lower) back in Feb 2007 and May 2007, when the price bounced off of this region and for the period between March and December 2009, when this region acted as resistance (failure of price to go higher).
• Formation of pin bar two weeks back in this region, which indicates sellers tried to push the stock lower, however, the buyers overcame the sellers and pushed the price higher.
• Annual dividends for Shaw Communications have been increased to $0.92 paid on a monthly basis which commences on March 30, 2011.
• Therefore, based on current price of $21, it pays an annual dividend of 4.38%, which is lucrative for a long term hold.

Personally, I feel this stock can potentially reach the $23.50 region before it consolidates. My exit would be at $20.

Thank you, Mark!

This post was included in the Carnival of Wealth, Stock Carnival Ecstasy and Carnival of Traders and Investors.

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