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TransAtlantic Petroleum: OPEC Might Cut Production, But Company Continues To Cut Costs

Summary

Malone Mitchell, Chairman and CEO of TransAtlantic Petroleum (NYSEMKT:TAT) was characteristically blunt about the challenges facing the company. The company had purchased a division in Albania, a division that has been kept separate from the rest of the company (as a Cayman Island entity) since its acquisition. That company division needed work and had some minor cash flow. The company had done its due diligence and knew what it was getting into. However, since the acquisition the oil markets changed to the point where the division in Turkey was not generating the cash flow needed to turn around the division in Albania and meet covenant requirements. The company had tried and so far failed to find a substantial investor willing to put cash into the division without also wanting to run the division. Therefore the company has put the division up for sale and reported the Albania operation as a discontinued operation. The CEO still feels that the division has great prospects but he is assuming that low oil prices will continue through 2016 and therefore the rest of the company will not generate in the future the money needed to fully take advantage of this division and meet the inherited financial obligations.

The twenty percent decline in oil prices led to a $16 million impairment charge, $13 million of that charge was an impairment of the properties in Albania. The company also took a $22 million non-cash charge for the currency devaluation of the Turkish currency. The company wrote off $1.8 million of accounts receivable. None of these charges affected cash flow.

Finally, the company had stated that should oil prices decline to the point where the hedges were worth more than $40 million, then the company would consider cashing in the hedges and paying down some bank debt. The net proceeds of $25.8 million was used to pay down bank debt when the company unwound some hedges. Roughly half of the proceeds were received before quarter end and the rest after quarter end during the month of October. So while the company reported hedges worth more than $30 million at quarter end, approximately half that value has now been liquidated. The company did replace some of the hedges with new hedging at a lower price.

The company reported production costs of $9.68 per BOE for the latest period. While that was an increase from the second quarter, the total increase and more was due to the Albania division. In Turkey, the continuing operations segment, the LOE decrease from $4.6 million to $3.1 million for an annualized savings of roughly $6 million.

The company estimated in its release that the Turkey division was roughly responsible for 5200 BOED out of 5900 at quarter end. Using a 90 day quarter for estimation purposes that gives roughly. So if 700 BOED is subtracted from the 5000 BOED that was maintained during the quarter, then the production costs are estimated at $8.01 BOE, a very attractive figure for the Turkey division. So the company could realize some very tangible savings per BOE from ridding itself of the Albania division.

In addition, continuing general and administrative expense dropped to $4.6 million from $6.3 million from the previous year for a total savings of $7 million. So management has realized an annual savings of $13 million between the LOE decrease and the G&A decrease. The G&A expense is roughly $10 per BOE. While this is higher than several companies that I have covered so far, the combined figure of $18.01 for the Turkey division is very attractive at these prices, even if that figure climbs a little if the Albanian division is sold. This company is doing just fine at current oil prices with its continuing business and that is rare in the industry.

“The market for new credit or equity in energy markets is very expensive. IBERIABANK gave me a market study last week which showed the average high yield debt for all companies is now running at approximately 18.6% versus 6% a year ago. Debt cost in Turkey would probably be even higher if that were available.”

This quote from the conference call, indicates the predicament of the company. The production costs are excellent as the company gains much of its revenue in dollars and has many of its expenses in Turkish Lira. That enables the company to operate relatively cheaply. However, the conflict in Syria and Iraq has scared away creditors to the point where the company cannot obtain loans to develop its properties. Even the properties in Albania, which are further away are affected. What loans the company does have it intends to pay off. It has an $8 million loan that it intends to pay off by April, for example. It has already (through October) paid down $25 million in bank loans, and may well liquidate hedges to pay more loans. This is one of the big reasons for the change in plans with regard to the Albania division. With current oil price quotes in the forties the company is very hesitant to invest more than cash flow in its properties and would prefer to pay off its outside creditors first before investing in its properties.

The company has stated in the past that with oil prices below $50 it will work on its balance sheet, and this year has improved the balance sheet with a vengeance that few companies can match. If oil prices head over $60, then the company will expand its capital budget. The in between numbers the company intends to plan for sub-$50 oil however, it may vary from that plan depending upon the outlook of management.

Currently the company states it has $55 million convertible (from shareholders), $9 million loan and then another $29 million loan. Should the company decide to liquidate the rest of its hedges (and right now, that looks like the intention) then it will pay down another $15 million or so of these loans of $29 million and $8 million. No matter what the company has a priority of paying off the $8 million loan by April. Shareholders holding a hotel have pledged the hotel as security for some of these loans. It is successfully ridding itself of nervous creditors (that want to raise interest rates) through some very astute management of its hedging program.

“I do believe there is a chance of a production cut at the December 4th OPEC Meeting, not a probability but a chance. So I would tend to favor lifting our remaining hedge volumes ahead of that meeting if current information remains consistent.”

This quote merits consideration by any investor who has followed the company. This is the same CEO that previously rushed to purchase hedges ahead of the 20% price decline that occurred in the beginning of the third quarter. Those hedges have earned the company more than $25 million so far and will earn the company another $15 million (in cash) at least if this plan is carried out. Those hedges plus the ones already in place have enabled the company to remove a third of its long term debt ahead of schedule. That amount of money is a gold mine for a company of this size. This company is making quite a bit of money from the hedges and that offsets some of the other unfortunate things happening as well as making the continuing challenges easier to bear. This is a very significant turn around in attitude by that same CEO. It also indicates for the first time, that a CEO is relatively upbeat about the future of oil and gas prices. This CEO has been extremely accurate about the future of oil and gas prices, made a lot of money for his company in the process, and therefore his actions bear watching. He may be signaling that oil prices have finally hit bottom, at least for the time being and may be about to bounce upward.

Even in this market, the Turkish Division generated income of nearly $18.3 million before income taxes from continuing operations. The whole company showed income of nearly $200K before currency translation adjustments (a non-cash charge) of $22 million. So operations in Turkey are quite healthy and throwing off quite a bit of income. Cash flow for the nine months was $38 million, and therefore makes the debt level look quite comfortable were it not for the instability of the neighbors surrounding Turkey. Turkey itself appears quite stable, and seems to have more than adequate plans to deal with its neighbors, plus it has a long history of surviving quite adequately in a very unstable region. However, the perceptions of Turkey right now are not favorable and for that reason investors and investment money are hard to come by.

The current ratio is still fairly weak at approximately .66:1. However, much of the current accounts payable is for related parties and therefore could be put off for a little bit if the company needed more time. With the emphasis on paying off the bank debt, that appears to be exactly what is happening. Most of the convertible debt is due to shareholders of the company and that more than $50 million is in very stable and patient hands. The faith of the major shareholders in the company has clearly kept this company going and can be shown by the amounts owed to shareholders in long term debt as well as accounts payable amounts. It has allowed the company to pay off some nervous lenders and yet still be viable.

If the situation in Albania can come to a reasonable conclusion. There is an excellent possibility that this company will show some decent cash flow for its size with or without that division. The company showed production of 5000 BOE per day in the third quarter and states that was pretty flat with the previous year. However, the company shows 5900 BOE per day of current production with another 400 BOE per day shut in, and two wells that need to be completed for production in the fourth quarter. This company therefore should have a fairly significant revenue jump in the fourth quarter provided commodity prices don’t drop significantly again. Plus the production in the division is profitable production. The only reason that the company did not report profitability was the currency translation adjustment, a charge that is typically non-cash and does not affect anything. Operations results are extremely strong compared with the rest of the industry. This company should do very well when the Albanian division situation is resolved.

The larger shareholders banded together to purchase the $55 million in convertible notes from the company as noted in the previous article. That saved the company from a very dim future this year. As noted in the conference call, some of the major shareholders continue to purchase stock through open market transactions. The major shareholders have shown their faith in the company by purchasing convertible securities, lending, pledging collateral for loans, and doing business with the company (allowing for lenient repayment terms if needed), and purchasing stock on the open market. These owners have sent a loud and continuing signal that they consider the company a bargain and will do what is necessary to see the company survive.

The president himself stated that the next few months will be challenging, but he has outlined the challenges facing the company and has discussed publicly the plans that he has available to deal with those problems. Few management’s are this upfront about the challenges facing them, and when management faces challenges, they usually achieve their goals to the benefit of shareholders. The current stock price has a lot of negative news built into it, and in case the shareholders missed any news, the CEO summarized the challenges at the beginning of the conference call, and then stated how he intended to surmount those challenges. A shareholder could not ask for much more, and therefore could find this stock very rewarding in the future.

From the previous article, the 1P reserves are $18.63 a share. While that will take a hit with lower oil prices and to some extent the sale of the Albanian division, probably two-thirds of the value will survive even in the current low price environment. There is plenty of value still to this company and much of that value has been discarded by the current pessimism. The actions of the biggest shareholders have been ignored by the market, at some point that will change and the market will realize what the major shareholders have seen in the company all along. With the Albanian division kept separate, there is every reason to expect the company to survive without that division should that become necessary.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.