Hits and misses in the energy sector

For Rafi Tahmazian, investing in Alberta’s energy sector isn’t just about looking at balance sheets and income statements. It’s personal.

“I was brought up around the energy industry,” says Tahmazian, senior portfolio manager and director at Canoe Financial in Calgary for the past seven years. Born and raised in Calgary, he demarcates eras in his life by major moments in the province’s energy fortunes. He recalls being in high school when the former National Energy Program upended the Alberta energy sector, and being part-way through university when oil prices collapsed in 1986.

After graduating from the University of Calgary’s economics program, he worked at an energy firm, and has been connected to the industry ever since.

“Oil and gas just becomes all-encompassing,” Tahmazian says. “It becomes your entire life.”

His father worked as a petroleum geologist and a professor. When Tahmazian was starting out, he met oil and gas professionals who had been taught by his dad. His brother also answered the family’s calling: he’s vice-president at Paramount Resources. So Tahmazian’s funds aren’t just a collection of companies; they’re portfolios of friends and family. When they succeed, he does.

“A big part of understanding the character of the company is understanding the character of the person,” he says. “It’s just an added advantage I think I have as an investor.”

Last year, one of Tahmazian’s funds—Canoe Energy Class Series A, which he co-manages with portfolio manager David Szybunka—was awarded the Lipper Fund award for best energy equity fund over both three and five years. In 2016, the fund returned 52.2%.

Hit

Canyon Services Group (TSX:FRC)

Canyon, a fracking services company in Calgary, was founded in 2004 with a staff of 16. Now headquartered in Calgary, their fleet’s capacity has grown by 10 times in the last seven years. All of its business is in Western Canada, handled from five operating bases across Alberta and Saskatchewan. Canyon fracks a site, provides the tubes and chemicals required, and then cements a well closed once it’s spent.

Putting it through the process

For portfolio management, Tahmazian breaks the Canadian energy sector into eight sections, or subsectors: conventional oil; unconventional oil (e.g., oil sands); gas; midstream and pipelines; energy services; renewables and alternatives; “other,” which includes uranium, coal mining and fertilizer; and cash.

Company stats

Canyon Services Group

Ticker: TSX: FRC (delisted)

HQ: Calgary

What: Fracking services company

Initial purchase price: $10.70 – $10.80 (Q2 2013)

Est. sale price: $16.90 – $18.53 (June 2014)

Repurchase price: $3.90 (March 2016)

Transaction price for Canyon shareholders: $6.63 (June 2, 2017)

Tamarack Valley Energy

Ticker: TSX:TVE

HQ: Calgary

What: Junior oil and gas company

Initial purchase price: $3.50 – $3.70 (Q4 2013)

Est. sale price: $4.20 – $4.44 (Jan/Feb 2014)

Repurchase price: $2.50 (January 2016)

Current price: $2.09 (June 19, 2017)

It’s rare that more than three of these subsectors are present in his funds at any time, he says. Currently, he’s mostly invested in conventional oil and energy services. He chooses which subsector he’s invested in based on how each is performing under present and predicted microeconomic, macroeconomic and macropolitical conditions.

For each subsector, he identifies best-in-class companies, which manage their capital well, have low debt levels and a record of successful projects. Above all—and Tahmazian acknowledges it sounds trite—he must be confident in a company’s management.

“Do I know them? Do they have a strong track record of success?” he says.

“We don’t do a lot of modelling here,” he adds. Tahmazian and his team keep up on companies’ financial results and analyst opinions, but his personal connections with management make it easier to keep up with company minutiae.

“I don’t have to spend all this time psychoanalyzing what they say, and then punch a bunch of assumptions into a model and see if they’re wrong or not. I can sleep at night knowing that a vast majority of the businesses that I invest in just take care of themselves,” he says. “That leaves me to worry about geopolitical and geoeconomic issues domestically and internationally.

“All my time is spent wondering what in the hell is going to come out of Trump’s mouth? Or what garbage is going to come out of Trudeau’s mouth? Or what new policy is the NDP [government] going to do?” he explains. “Does it affect the direction of my sector right now? What’s influencing international desire to invest or not invest in Canada?”

What sets Canyon apart from other fracking companies is the complexity of their work, Tahmazian says. “A lot of these service companies, it’s a commodity,” he explains. “There’s not a lot of technology to what they’re doing; it’s not manpower-intensive, it’s not science-intensive.” But in Canyon’s case, the equipment is more expensive, raising the barriers to entry. “It’s manpower-intensive,” he says. “It’s multiple facets of the process of completing a well.”

Tahmazian starting building a serious position in Canyon in the spring of 2013, at a price ranging from $10.70 to $10.80 a share.

A year later, it made up 2.5% of his fund.

Turning point

Tahmazian sold his stake in Canyon in June 2014, when it was trading between $16.90 and $18.53. To reduce risk, he was moving his fund out of every sector, and was holding upward of 70% cash. The fund’s performance report explains that demand for fracking companies drastically declined when oil prices began to drop toward the end of 2014.

In the dust of the price collapse, energy companies found operating efficiencies, including new ways to frack. At the same time, the Canadian dollar’s value dropped, helping commodity sellers with goods priced in U.S. dollars. Energy companies could still turn a profit and, by early summer 2016, Tahmazian believed fracking production was poised to pick up again.

Canyon was well-positioned to benefit from a pickup because the company had stayed strong during the price collapse, he says. CEO and president Brad Fedora “kept up with innovation, he kept up his fleets—they’re best in class. And he kept his balance sheet in check and retained a lot of good people from management and crews,” Tahmazian explains.

“We felt that there was the possibility that pumpers, like Canyon in particular, were going to have a lot more demand—to the point where they could even look at charging a little more,” he says. “The thought that you could even raise rates again was phenomenal.”

He reinvested in Canyon in March 2016 at $3.90. By June of that year, fracking companies like Canyon were part of the best-performing subsector in the fund. He has continued to buy Canyon, and it’s a top-10 holding. By January 2017, it made up 3.8% of the Canoe Energy Class.

Results

This March, Canyon announced a deal for its acquisition by competitor Trican Well Service, for $637 million. The two companies plan to merge in 2018, creating one of the largest hydraulic fracking firms in Canada. Under the offer, Canyon shareholders would receive a 32% premium on its stock price; its shares jumped 19% on the news.

Analyst reaction was mixed. One noted that both companies currently have fracking equipment sitting idle, so it wasn’t clear why Trican was motivated to expand. Another argued the combined company could ramp up work quickly as the energy sector recovers.

Tahmazian says the deal is part of a consolidation trend in the energy industry—the reasons for which form part of his macroeconomic analysis. He says the current federal and Alberta governments have signaled less favourable regulatory and business environments for energy, adding downside to the investor’s view of Canada. He cites a global survey of energy company executives by the right-leaning Fraser Institute.

The survey ranks Alberta 43rd out of 96 in terms of the perception of policies supporting energy investment. In 2014, the province was 14th. That worries Tahmazian because there isn’t enough Canadian investment money to fund the energy sector on its own.

The deal closed in early June and Tahmazian did not sell Canyon’s shares. They were transferred to Trican at a value of $6.63 per share of Canyon. While he now holds Trican and was supportive of the merger, he remains concerned as a member of Alberta’s energy community and as an investor with fewer choices.

“These companies are forced to look at growing by combining. The short-term gain you get from a little share bump on Canyon—that is insignificant to me. What I lose is one more entity that I get to invest in. And that disappoints me,” he says.

CHART 1: Proposed Keystone XL route

Miss

Tamarack Valley Energy (TSX: TVE)

Tamarack, headquartered in Calgary, is a junior oil and gas drilling company founded in 2002. The company focuses on reserves in Alberta and Saskatchewan that can turn a profit in less than 1.5 years, and are sustainable under low commodity prices.

Putting it through the process

Tamarack came to Tahmazian’s attention via its CFO Ron Hozjan, who was a colleague at Renaissance Valley Energy in the late 1980s. Hozjan introduced Tahmazian to Tamarack’s CEO, Brian Schmidt.

“Brian impressed me,” says Tahmazian. “They understood that they needed to be bigger, quicker.”

The company was trading on the TSX Venture Exchange in Calgary. Tahmazian didn’t invest right away. Instead, he monitored the company’s growth. In fall 2013, Tamarack was producing record cash flow and oil. That year, it also announced a 98% increase to its proven and provable oil, natural gas and liquid natural gas reserves. When Tamarack bought Sure Energy for $25 million in October 2013, he decided to invest.

He bought Tamarack in Q4 2013 at $3.50 to $3.70 a share. The position made up 4.3% of his portfolio at the time.

Turning point

Tahmazian sold Tamarack in January and February 2014, when the stock was trading between $4.20 and $4.44. He says the move wasn’t a reflection of either firm, but more broadly of the sector. He sold off smaller companies in favour of larger firms and a bigger cash position.

“This was about protection,” he says.

During the oil price correction, Tahmazian’s portfolio was as much as 77% cash. He spent 2014 and 2015 examining companies, the sector and the Canadian economy. That meant reviewing energy reserves, company balance sheets and major purchases, as well as currency trends.

Last year, when his fund was one of the country’s best energy portfolios, he says it was about 20% cash. As the energy sector improved, he continued to buy stocks. By late May 2017, cash made up around 13% of the portfolio. Tamarack was one of the first oil and gas names Tahmazian re-purchased as the energy sector recovered. He rebought in January 2016 at $2.50.

In August 2015, Tamarack, which had traded on the TSXV, listed on the TSX. In a series of deals over that year and the next, it bought energy assets all over Alberta and into Saskatchewan.

Tamarack’s largest purchase was Spur Resources for $407.5 million, announced in November 2016. Tamarack called the deal “transformational” because it opened access to a large reserve of high-quality light oil across about 700 drilling locations. The company expects that 468 of these locations will be profitable by 2018 under asset prices at deal time.

Results

Tahmazian likes that Tamarack blends organic growth with acquisitions. With the Spur purchase, the company “went from a large small cap to a small intermediate,” he says. “It was one of the smaller producers I owned, up until that transaction, and I deemed that to be a risk.”

As of early June, Tamarack was the sixth-largest position in his portfolio, at 3.5%, and it was trading at about $2.25. The company issued more than 90 million new shares to finance the deal, which diluted their value. With the stock still trading below his most recent purchase price, he isn’t selling.

“I have to be patient and wait for the cleanup,” he says. “On the other end of that, if they achieve all their operational success, then I think it’s going to bear fruit.”