Steve Smith, CEO and portfolio manager with Hesperian Capital Management, focuses a lot on the four P’s: people, prospects, production and profit. “But our sweet spot is conversion from prospects to production,” says the energy sector specialist. “So they have a production base, but more importantly, they have a good prospect inventory that they can continue to convert into production.” With a volatile sector like oil and gas, companies need to have strong management track record, Smith says. “We do like battle-worn guys who are tried and true.”
And while assessing whether young companies will eventually be churning out profits is difficult, Smith looks for strong recycle ratios—the total profit per barrel of oil or cubic metre of gas, divided by the cost of finding it and producing it—to catch a glimpse of profitability. “There’s lots of guys that can tout a resource play, but actually converting it into profit has proved elusive.” The Norrep Income Growth Fund Class MF, which Smith manages along with Hesperian colleagues Alex Sasso and Keith Leslie, took home a Lipper Award last year for best Canadian equity balanced fund over a three-year period.
Steve Smith’s Picks
Legacy Oil and Gas
1-yr total return: 37.3%
Legacy suffered from bad timing. It was set up to grow through acquisitions just before the energy sector tanked, whereupon the markets orphaned it. Nonetheless Smith thinks the company got the fundamentals right and makes for a smart value play. “They’ve built a base for a much more sustainable growth profile.” He suspects that Legacy will become hot once again in 2014. Now that the sector is rebounding, he says, investors “are going to start looking for the ones that are less expensive with significant upside, and Legacy certainly fits that bill.”
Peyto Exploration & Development
1-yr total return: 42.5%
If the polar vortex caused a spike in your home heating costs, Smith has a solution for you. “If you want to hedge against your furnace bill, you might as well just buy Peyto.” The gas company pays a modest dividend of 2.4%, but more important, it’s the lowest-cost operator in Canada. With less than 50 people at the company, producing the equivalent of 70,000 barrels of oil a day, Smith says that it has the best “gas-to-ass ratio” in the business (a term coined by Peyto). “They run a very mean machine. So if you’re looking for gas leverage right now to commodity price upside, Peyto is as solid as it gets.”
1-yr total return: 54.4%
If you’re looking for strong growth prospects, Smith recommends Secure Energy. Secure services oil and gas companies, especially disposing of fluid waste. Back in 2009 Secure had a 6% market share; that has shot up to 17%. “They’ve been growing through acquisition, they’ve been growing through grassroots additions, so we definitely like their growth prospects,” Smith says. As the youngest of only a handful of major companies in the market, Smith likes their nimbleness. “Secure was able to move into high-growth areas where industry was moving. They didn’t have the millstone of established areas,” he explains.