TransGlobe Energy Corporation is a $550 million upstream oil and gas company headquartered in Canada, but with the vast majority of its operations located in Egypt. I’ve written before about searching for crises to look for stocks that have been overly beaten up by a herd of investors under the influence of what I call “mob mentality psychology”. Given the political and economic instability in Egypt in the wake of the revolution against Hosni Mubarak in January 2011 as well as the uprising against Mohammed Morsi in June 2013, and the complete halt of Western investment, I believe TransGlobe is one such stock.
Disclosure: I am long TransGlobe Energy Corporation (TSE:TGL, Nasdaq:TGA) and it is one of my top picks for contrarian stocks in 2014.
Investors in Canada’s TransGlobe Energy are eagerly awaiting a widely anticipated dividend announcement by the company’s board of directors during the upcoming fourth quarter earnings release on March 5th, 2014.
Although TransGlobe’s management has given no numerical indication as to the size of the likely dividend, they have given hints in the form of descriptive language that I will explore in this article to get a rough idea for how large the dividend will be.
The company’s rationale behind strongly considering initiating a “modest dividend program” was presented by Randy Neely, VP of finance and CFO, during the third quarter 2013 conference call:
“Given the magnitude of the differential between what we expect the funds flow to be and what we expect to spend in Egypt over the next several years, we expect to continue to build a fairly large cash balance.”
Just how large is the differential between what TransGlobe expects funds flow from operations to be versus capital expenditures? Well, funds flow is expected to be roughly $140MM (USD) in 2014, and capex is currently expected to be around $100M per year for the next several years, so the differential is approximately $40MM.
Randy continued to discuss whether the dividend would impact growth opportunities:
”We think we can handle both providing some capital back to our shareholders, while at the same time continuing to pursue other acquisitions and opportunities.”
TransGlobe has about $125MM cash on hand, as well as over $300MM in net working capital. If the company wanted to provide some capital back to shareholders while maintaining the “firepower” necessary to make acquisitions, then the obvious answer would be to fund the dividend via the $40MM differential between funds flow and capex.
Ross Clarkson, president and CEO of TransGlobe Energy, later carried on at another conference call that the dividend would be an amount that is “sustainable without impacting our growth plans”.
This further supports my reasoning that the dividend will likely be funded by the differential because a truly sustainable dividend in the long-term must be funded by excess free cash spun off from the operations of the business, and TransGlobe needs to avoid drawing down its cash balance too much given the regional instability as well as the potential for acquisitions, farm-ins, and further EGPC bid rounds in Egypt.
Therefore I think it is highly likely that the dividend will be less than the differential between cash spent per year versus cash generated by the projects, or about $40MM as an upper bound.
This would represent a quarterly dividend for TGL’s shares of $0.135, or an annual yield of 6.6% on today’s stock price of $8.19.
Now that we have our upper limit, what is the lower limit likely to be? Ross Clarkson shed some light on that with this statement from a recent conference call:
“It will be significant, but it won’t be a giant lump sum. It will be a continuous thing.”
Given TransGlobe’s net working capital position of over $300MM, and its cash position of over $125MM, and its surplus funds flow of $40MM, I don’t think any value less than $20MM per year could in any way be considered “significant”. A dividend of $20MM per year would represent about 50% of the excess cash generated by the current wells and a little over 6% of the current working capital – a fairly insignificant amount.
Therefore I also think it is highly likely that the dividend will be greater than $20MM per year, the lower bound.
This would represent a quarterly dividend for TGL’s shares of $0.0675 or an annual yield of about 3.3%.
If we split the difference between the upper bound and the lower bound we get a dividend yield of roughly 4.9%, or a quarterly dividend of $0.10 per share. This is a dividend that satisfies both descriptions: a dividend yield of close to 5% is certainly “significant” but it is also “sustainable” because it will be funded by excess cash generated by the business. So my thinking is that on March 5th TGL will initiate a dividend of around 10 cents per share. This is all extremely rough so please don’t trade or invest based on it. But I do know a significant number of TransGlobe shareholders who are extremely excited about the upcoming dividend and what they think it will be, so I thought I’d give my 2 cents on it.
This article comes from Mike Mask. You can follow Mike on twitter at @contrarianville