Buy Sell and Tell Investments

Analysis:

When deciding which stock to add, it makes sense to compare stocks that are in the same industry to see which stock is cheaper on a relative basis (everything else remaining the same). Ideally each of the stock analysis that follows will eventually be valued against another stock in the same industry to determine relative value.

Destiny Resource Services (T-DSC) last updated June 8

Background:

Destiny Resource Services (T-DSC) provides services (such as seismic surveying, mapping and line clearing) to the oil and gas sector. The majority of its business is in Canada but it is expanding in the US. Business is highly dependent upon the price of natural gas and the amount of exploration for gas. Business is highly cyclical with the 1^st quarter being the strongest followed by Q3, Q4 and then Q2.

2007 saw the price of natural gas decline to less than $8 in the second half of the year as inventories rose above average. In 2008 the price of natural gas has rebounded to over $12 and inventories have been drawn down. Natural gas is now at its highest level other than the temporary spike caused by the hurricanes (Katrina and Rita) in 2005. As a result, companies have been much more active in exploring for natural gas.

Earnings:

Earnings Per Share for the 2007 year were only $0.05, but EPS in 2006 was $1.37. EPS rebounded for the first quarter of 2008 to $0.35 compared to $0.30 in 2007.

Leverage:

Debt was $7 million and Equity was $13.5 million resulting in a low debt to equity ratio of around 33%.

Free Cash Flows:

Not surprisingly as a result of the low profits in 2007, the company Free Cash Flow was zero but 2006 was positive.

Summary:

Destiny is a good company to own for a number of reasons:

-natural gas prices are high yet when compared to the price of oil, gas is very cheap and should keep increasing

-operates only in politically stable countries (Canada and the US)

-is cheap on a P/E basis…current price is $4.05 compared to Q1 earnings of $0.35; due to the cyclicality of the business, one shouldn’t extrapolate out the earnings for the full year

-has low debt

The negatives against the company are:

-high concentration of business with 2 clients.

-highly cyclical

-high dependence upon the price of natural gas

-the volume of stock trading is very low making it difficult to buy or sell a position

Investor Implications:

Buy Destiny as a cheap way to get exposure to natural gas. Demand for natural gas should continue to increase as a result of increasing oil sands production (gas is required to heat up the oil sands and as a feedstock), increasing production of fertilizer (gas is a feedstock), increasing concerns over greenhouse gases (natural gas is very clean compared to coal) and increasingly hot summer weather (natural gas is required to fuel the air conditioners). If oil remains above $120 a barrel, the price of gas needs to increase from $12 to $20 to be comparable to oil on a price and energy basis.

Quadra Mining Ltd (T-QUA) last updated May 5

Quadra mines copper in the US from the Robinson mine, has another US mine under construction and is developing a Molybdenum mine in Greenland and a copper mine in Chile. Numbers are presented in thousands of USD.

It has a cash cost of $1.49/pound in 2007, down from $1.76 in 2006. Company expects production for 2008 to be flat.

Copper production from the second mine originally expected to start in Q2 is now slated to start in Q3.

Reserves:

The Robinson mine is an open pit operation that also produces gold and molybdenum as a by product with an estimated mine life of 7-8 years. If the Chilean and Greenland resources can eventually be added to the proved and probable reserves, they would cause the reserves (which look on the low side) to triple.

Earnings:

Earnings for the year were USD$136,412 or $2.80 per share in 2007, at a stock price of $22.00 this represent a price earnings ratio of 7.9. Also included in the 2007 results were about $20 million of losses resulting from derivatives and debt repurchases. This P/E ratio makes the company one of the cheaper copper companies.

Leverage:

Debt was $141,151 and Equity was $498,379 resulting in a low debt to equity ratio of 29%. When you include the cash and cash equivalent position of $263,586, the company is actually in a net cash position. Obviously a company that sits on cash is better than a company with debt.

Free Cash Flows:

Cash Flows: in 2007, the company had negative Free Cash Flow of $23 million after some large capital expenditures. In 2006, the company had positive free cash flows of $48 million.

Summary:

Quadra is a good company to own for a number of reasons:
-mines copper which is in high demand and should remain high for the foreseeable future
-operates only in politically stable countries (US, Greenland and Chile)
-is cheap on a P/E basis
-has no net debt

The negatives against the company are:
-negative free cash flow
-proved and probable reserves are low at 7-8 years

The negative free cash flows in 2007 were the result of large capex of $141 million compared to $17million, $11 and $7 in the 3 previous years 2006 to 2004 respectively. The proved and probable reserves have the potential to triple if the company is able to bring the 2 other large mines on line.

Petro-Canada (T-PCA, N-PCZ). Last Updated April 21, 2008

PCA is an integrated Canadian oil and gas company with the majority of its reserves in Canada. Its Canadian reserves are concentrated mostly in the oil sands as well as in the off-shore (east cost). The majority of the reserves and the earnings are weighted towards oil, rather than gas. All figures in Canadian dollars except where indicated.

Earnings:

Earnings in 2007 were $2,733 billion and $1,588 in 2006. On an EPS basis earnings in 2007 were $5.53, 2006 and 2005 they were $3.41, 4^th quarter earnings were only $1.07 and represented the lowest quarter for 2007. Revenue and investment income was flat for Q2, Q3 and Q4 but the large increase in crude oil and product purchases cost caused the Q4 to under perform. I find it odd that quarterly earnings were down as a graph of oil prices shows a straight line going upwards from the beginning of the year to the end of the year. As a result, you would expect to see earnings increasing each quarter since average oil prices were 11% higher in 2007 than in 2006.

The Canadian dollar strengthened 5.5% in 2007 offsetting some of the impact from higher oil prices. Natural gas prices were 5% lower in 2007 than 2006 also negatively affecting earnings. There were some unusual items in 2007 including losses of $331 million on the Buzzard derivatives contract (compared to $240 million in 2006). When all the gains and losses are netted, 2007 had a net unusual gain of $120 million compared to a loss of $53 in 2006.

Natural gas only contributed $191 million to net earnings in 2007 down considerably from $405 million in 2006.

Free Cash Flow:

Free cash flow in 2007 was slightly negative in 2007 and slightly positive in 2005 and 2006. 2007 cash flow was negatively affected as a result of $1.7 billion to settle all the derivatives related to the Buzzard acquisition.

Leverage:

Leverage: There’s $3.5 billion of debt and $11.8 billion of equity giving a low debt/capital ratio of 23%. There was no documented litigation against the company as of 2007.

Reserves:

Proven reserves increased from 1,274 million barrels in 2006 to 1,315 in 2007. 291 million barrels of the reserves are from North American natural gas, 298 million barrels of reserves are from international sources, the remaining 726 million barrels is in Canada, 626 related to oil sands. Given the production of 153 million barrels in 2007, the reserve life index of proved reserves was 8.5 years. PCA reports in their most recent investor presentation a total of 15 billion of oil resources of which only 2.4 billion is classified as proved and probable. Proved and probably reserve life index is a much more respectable 15.6 years and the resource reserve life index is a whopping 98 years.

Summary

At a stock price of $51 and EPS of $5.53, the P/E ratio is 9.2 which makes it one of the cheaper (or cheapest) of the large oil companies. Its exposure to the oil sands is positive in that it provides very long lived reserves, but is negative due to the high expenses involved in the extraction and the lower price received for the heavy oil. With a proved and probable reserve life of 15 years (longer than average) and a resource reserve life potential of 98 years, Petro-Canada is well positioned for many years of solid earnings.

Amerigo Resources (T-ARG)

Amerigo is a copper producing company in Chile, South America.

I bought Amerigo for $2.19. Amerigo announced last week that copper production for Q1 had increased 23% and the smaller molybdenum production increased by 20%. Copper sales prices were up 26% over Q4 and the provisional sales were revised higher by 17%. Company warned that power costs rose to unprecedented levels and will impact earnings.

Earnings:

Earnings per share in 2007 were $0.26 ($24.2 million) but included some unusual gains ($2 million). Excluding the unusual gains, the EPS is $0.24 which works out to a P/E ratio of 9.15. Based on 2007 numbers this isn’t a particularly great number, but given the 20-26% increase in production and prices in Q1, I would expect the earnings to increase significantly and the P/E ratio to drop. Even at a 9.2 P/E, this is still significantly lower than most of the stocks in the North American stock exchanges.

Debt:

Company has no debt and has a cash balance which is obviously the best you could hope for.

Free Cash Flow:

In 2007, FCF was zero and in 2006 it was positive $6million. Company has been paying dividends which it has been financing by issuing shares. I would prefer the company stop paying the dividend and stop issuing shares as the 2 activities simply cancel each other out and are a waste of time.

BCE Inc (T-BCE,N-BCE)

I bought call options on BCE Inc (T-BCE, N-BCE) with a May expiry when the stock was trading at $36.10 USD. I bought BCE purely as a takeover play and not based on company fundamental, as a result there is no fundamental analysis here. BCE is the object of a friendly takeover at $42.75 Cdn, which means it trades at a fairly steep discount of around $6.00. The stock was down on news that a filing deadline for the firm had been extended which I thought was a non-event. The biggest obstacle remaining for the takeover to be completed is an appeal of the Quebec Superior court decision by the BCE bondholders. The hearing is scheduled to wrap up at the end of this week. Here’s the info from the BCE website:

The schedule established by the Court of Appeal provides for three and a half days of hearings, over a maximum period of five days, beginning on April 28, 2008. The Court has indicated that it expects to render a decision expeditiously.

“We are very pleased that the Court of Appeal has agreed to a schedule that will allow for the expeditious resolution of these appeals,” said Martine Turcotte, Chief Legal Officer of BCE and Bell Canada. “Our position from the start, which was supported on every point of contention by the Québec Superior Court, is that the claims of these debentureholders are without merit. We believe that the Superior Court’s decisions will be upheld. As the Superior Court has concluded, BCE and Bell Canada have respected all of the rights and reasonable expectations of the debentureholders,” added Ms. Turcotte.

As a result of the Court of Appeal schedule ordered today, BCE now expects the transaction to close before the end of the second quarter of 2008.

Another reason the stock is trading at such a discount to the takeover price is the fear that the banks might fail to provide the financing. I don’t think this is likely as bond traders have told me that it is unlikely that the banks would be able to legally back out of the deal by not providing the financing.

The options trade on both the Canadian and US exchanges. I purchased my position in the US with a strike of $30 when the stock was trading at $36.10 USD; the premium on the call options was $6.50 which means the options only had $0.40 of time value. Although there is more liquidity on the US exchange, the bid/ask spread was still high at $0.70. Obviously I’m hoping that the appeal by the bondholders is rejected and the announcement is made before the options expire on May 16 (hopefully “expeditiously” means within 2 weeks). If this happens the stock should trade close to $42.75 Cdn and my profit will be around $6.00. If the appeal is allowed, most likely the stock will plummet and I’ll have to sell the options for a big loss ( my maximum loss is the premium of $6.50). If the decision is delayed and the stock remains where it is, my position will lose $0.40.

My feeling is that the superior court decision will be upheld and the takeover will go through as the goal of the executives is to maximize shareholder value. Executives have responsibility to many stakeholders: customers, suppliers, employees, bond holders etc., but their ultimate responsibility is to the share holder. Bondholders have protection in the trust indenture or base shelf prospectus. If bond investors didn’t seek financial covenants or a change of control covenant, that’s an oversight on their part. Purchasing bonds without these restrictive covenants allows the bond investor to get a higher yield, but at the risk that the company could be taken over with an LBO (leveraged buy out). I’ve been talking to members of a bond syndicate and their feeling is that similar bond issuances like BCE won’t be successful without the covenants. I certainly wouldn’t buy any bonds without these covenants and the firm I’m working for is being asked by investors to include them. Since bondholders have the opportunity to protect their own interests I would be surprised (and poorer) if the judge overrules the previous judgment.

I bought the call options on the US exchange because there was more liquidity and because of the inherent volatility as a result of the foreign exchange. Since the takeover is priced in Canadian dollars, the call options in the US have more volatility than the Canadian options. If the Canadian dollar strengthens, then the price of BCE in USD will increase and so will the USD call options. When you are long call options, you want a lot of volatility as this increases the chance that the options will be profitable. If because of volatility the stock could go up or down $20 with equal probability, my position only has exposure to the premium I paid (i.e. $6.50) even if the stock goes down $20. If the stock goes up $20, I’ll participate in all of the upside (i.e. $13.50 = $20.00 - $6.50). I don’t expect BCE to have this much volatility, but the US call options will have more volatility than the Canadian call options.

CV Technologies Inc (T-CVQ; biopharmceutical and health supplements):

This company also has a low P/E ratio of 8.5 based on the last quarter results earnings of $0.07/share. The most recent quarter is the best quarter of the year, but I am hoping that the 2nd quarter will show some profits given the long flu season (anecdotally it seems to be dragging on here in Vancouver, checking out the flu reports also shows most cities across Canada still have moderate to high activity as well). I think this company has a lot of potential should it ever crack any markets outside of Canada. Even if it is business as usual, I don’t mind owning a company that has made a decent annual earning in its first quarter. Don’t let the low price (or high price) of a stock scare you off, as everything is relative.

My investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security.