Saturday, October 26, 2013

Mart Resources Article by Cara Jacobsen of D3 Funds

Mart Resources (MMT.V)
Cara Jacobsen
Please see important disclaimer at end of this article


Rapidly growing, low cost producer of light, sweet crude with low exploration risk
Significant reserve growth potential through drilling at Umusadege field
Local knowledge and expertise in Nigeria – management has operated in country for more than 20 years
Benefit of marginal field program’s lower taxes and royalties on production, and less competition for new assets
Strong balance sheet
Potential for growth through access to additional marginal fields released by Nigerian government and divestitures by majors operating in country
CEO is a large personal shareholder
Commitment to return capital to shareholders through $0.20 per share annual regular dividend and potential for special dividends of excess cash flow
Undervalued at less than 4x 2013 CF, 0.85x 2P NPV (0.7x 3P NPV), and a 16% dividend yield
Multiple near term catalysts should drive stock price higher over next 12 months

Company description

Mart is a growing small cap ($435MM CAD) exploration and production company producing light, sweet crude oil from the Umusadege field in theonshore Niger Delta region of Nigeria.  Mart is headquartered in Calgary, Alberta, and traded on the Toronto Venture Exchange, but all operating assets are in Nigeria.  

Mart operates and is developing the Umusadege field in partnership with indigenous Nigerian companies Midwestern Oil and Gas and Suntrust Oil Company, as part of the Nigerian government’s “marginal field program.”  Although Nigerian geopolitical concerns heighten risk perception, Mart has effectively managed these risks through strong government relationships, the hiring of local staff and management, and community investment and outreach.  

Investment Hypothesis

Mart will grow production 2.5x at its core strategic asset, the Umusadege field, from 12,500 bbls/d in 2012 to 30,000+ bbls/d in 2015, growing earnings and cash flow per share from $0.15 to $0.60 and $0.30 to $0.75respectively, over the same time frame.  Production, earnings, and cash flow could grow even more should Mart gain access to additional marginal fields for development.  Growth in production and earnings, new listings on the Toronto and London Stock Exchanges, and building of credibility with investors from stable performance and a new CFO tasked with investor relations, should drive a multiple re-rating from 4x CF to 6 – 8x.  (Mart will always trade at a discount to peers located in more stable geographies.)  This combination of earnings growth and multipleexpansion would yield a $4.50 stock price (at the bottom of the range).  Adding in $0.40 in dividends during a two year holding period yields a total return of almost 300(a 4xfrom the current share price of $1.25.  Should management sale the company, an acquisition premium may yield an even higher price.  

Mart faced several challenges in 2013 with a 3.5 month shut down of its sole export pipeline and delays in drilling and pipeline construction due to flooding, weather, technical issues, and vandalism.  These issues caused a short term hiccup in cash flow causing investors to worry about the sustainability of Mart’s dividend.  D3 feels comfortable that Mart can and will maintain its dividend and could increase the dividend in future years depending on growth and profitability.  Management and board are strongly committed to returning capital to shareholders.  

Wade Cherwayko, founder and CEO, is a large personal shareholder.  He has publicly stated his intention to prove up the additional value at Umusadege through additional drilling and increased export capacity, add a second marginal field and bring it to production, growing total company production to 60,000 to 80,000 bbls/d, and then sell Mart to a large independent looking for access to Nigeria.  Likely suspects might beHeritage Oil or Tullow Oil.  


Mart currently produces approximately 12,500 bbls/d from six wells at its Umusadege field.  All production is transported through an Agip (ENI subsidiary) pipeline to the Brass River Export Terminal othe Gulf of Guinea.  Mart realizes Brass River pricing, which sells at a premium to Brent crude.      

Mart’s average cash cost per barrel is approximately $31.50 (when producing at capacity), including cash taxes and royalties.  At current Brent prices of around $110 per barrel, Mart generates significant cash flow, and will continue to even in the event of falling oil prices.  Depletion, depreciation, and amortization (DD&A) is about $15 per barrel, allowing Mart to earn strong GAAP margins and earnings as wellas strong cash flows.  Taxes will increase in 2014, but Mart will still generate strong returns.

Production has grown from nothing in 2007 to 12,500 bbls/d currently.  In the last three years, Mart has increased reserves by 26% annually, after depletion caused by production.  Current production is constrained by export pipeline capacity.  The six wells currently producing have capacity to produce approximately 18,000 bbls/d, but Mart is limited to 12,500 by AGIP.  Mart was recently awarded additional capacity in the AGIP pipeline, but equipment upgrades on the pipeline are required before they can flow the additional oil.  

Mart is currently finalizing a crude handling agreement with Shellwhichwill allow Mart to export crude through Shell’s pipeline to the ForcadosExport Terminal in Eastern Nigeria.  The crude sales agreement between Shell and mart has already been signed.  Announcement of the final crude handling agreement has been delayed several times, but D3 understands the delay is purely due to process, not a fundamental disagreement.  Construction of a 50km trunk line connecting Mart’s operations to the existing Shell pipeline is fully permitted and under construction with “right of ways” secured and should be completed at the end of Q1 2014.  Mart has a partial ownership in the pipeline, requiring a modest capexinvestment that has already been funded.  Mart will have 40,000 bbls/d of export capacity at the Shell pipeline when it comes online, and intends to retain its existing capacity through AGIP as well.  Shell has better securityalong its pipeline than Agipprotecting the pipeline against “bunkering”, which is rampant in Nigeria.  “Bunkering” is what they call thieves who tap into oil pipeline and siphon off production to sell on the black market.  This bunkering causes pipeline losses in the billions on an annual basis in the country.  We assume pipeline losses will decline to approximately 8 – 10% from approximately 16-18% currently when Mart shifts export routes, increasing production, cash flow, and NPV of reserves.  In addition, we expect less days downtime, as Mart will have an alternative route for export should one pipeline be down due to equipment failure, adverse weather conditions, or vandals.    In addition, Mart could sell its excess pipeline capacity to third party producers to earn a spread.

Mart recently completed construction of a new processing facility at Umusadege field, increasing its internal production capacity to 35,000bbls/d.  A seventh well, UMU 10, has been drilled and tested.  Based onthis initial data, UMU 10 should produce approximately 4,000 bbl/d, from 2 sands.   The sands at UMU 10 (6 total being tested) are not currently included in 2P reserves of 17.8M barrels.  Mart completed drilling ofUMU 11 in September and is currently logging, surveying, and sampling.  Mart recently brought a second drill rig on site (owns the first rig).  The second rig is drilling a water disposal well and will re-enter an old well to drill a horizontally when the water disposal well is completed.  The horizontal well should produce approximately 2x the bbls/d as similar vertical wells in the field.  These three development wells should increase production capacity to approximately 34,000 bbls/d (from the current 18k capacity).  They will be tied into the Umugini (Shell) pipeline, when it is completed, which will more than double production from current levels.  We assume this production level will be achieved Q3 2014.  The randomness of weather and Nigerian bureaucracy cause us to be cautious about forecasting timelines, but significant progress has been made executing on these goals since we have been an investor.

After completion of the development wells, Mart intends to drill exploration wells to the East and West of the current core of the Umusadege field to increase reserves and future production.   Drilling of exploration wells will only come after Mart has drilled up the capacity to significantly increase near term production.  We expect an updated reservereport in Q2 or Q3 2014 with a significant increase in reserves, adding in the additional development wells and lowering loss reserves for pipeline bunkering.  

Mart’s deal with partners Midwestern and Suntrust requires Mart to put up 100% of development capital, but then take an outsized share of cash flows from new wells until it has fully recouped its investment.  For this reason, Mart’s share of cash flow fluctuates greatly, but should average about 62.5% over the long term.

This trajectory suggests that Mart will grow from a 12,500 bbl/d average in 2012 to 30,000+ bbls/d for the full year 2015, assuming no further development or acquisitions.  This may be a conservative assumption.  Mart hasn’t pursued further development of the Umusadege field in the past due to a lack of export capacity and an unwillingness by local partners to invest capital that will not generate near term cash flow.  With capacity to generate returns on investment, we expect Mart will develop Umusadege to take full advantage of its new production facility and export capacity.  Mart’s local partners are not publicly traded, and therefore are not concerned with reported reserve levels, which has been a challenge for Mart, as proven reserves do not give the company a long horizon for production.  They are working with Suntrust and Midwestern Oil to approve spending on field development despite not recognizing a near term cash ROI.  

In addition, Mart hopes to get access to additional fields through Nigeria’s marginal field program.  The government has indicated plans to release additional fields, but the allocation of the fields continues to be delayed.  Given’s Mart’s success at Umusadege field, one of the most successful assets from the original marginal field allocation, and its alliance with the Niger State government and with two highly respected indigenous partners, we would expect Mart to be successful in the next allocation.  Cherwayko spends a significant portion of his time building and maintaining relations with all levels of the Nigerian government.  It is public information which fields will be allocated, and Mart has already identified its desired assets and local partners.  Mart hopes to gain access to additional fields in 2014 and begin production in 2015.  Because the marginal fields have proven reserves, time from purchase to production should be minimal.    

There is a possibility that Mart could merge with a domestic partner, giving that partner 51% ownership in the company.  This would allow Mart direct access to marginal fields, as opposed to operating through domestic partners.  Such a transaction would improve well economics, as Mart would be entitled to 100% of cash flow, as opposed to its current average of 62.5%.  It would also allow Mart to achieve its current advantageous economics (discounted royalties and taxes) on all fields in Nigeria, as opposed to only fields in the marginal program, in which case we would expect Mart to acquire high quality assets in the near term.  The Majors have been selling onshore assets in Nigeria recently as they expand to Offshore areas with much larger reserve potential.  Mart has looked at these deals but the prices paid have not met their return requirements, and without the tax and royalty advantages they currently have at Umusadege, looked even less attractive.  

Mart is currently pursuing listings on the Toronto and London Stock Exchanges, which should help drive volume and multiple, as more investors gain access to the shares and the Mart story.  

Nigeria Overview

Nigeria is the most populous country in Africa, with an estimated 160 million people, and is one of the most rapidly growing economies on the continent and in the world.  Nigeria has the largest oil and gas reserves in Sub-Saharan Africa with an estimated 30B+ bbls of oil and 30Tcf of natural gas.  Estimates suggest Nigeria produces 2.3M bbls of oil per day,making it the 12th largest producer in the world.  (Some industry experts are skeptical of figures released by the Nigerian Government.)  Major Oil companies have operated in Nigeria for decades, as have large independents; infrastructure and fiscal and regulatory regimes for oil and gas production are well established and stable.  

Of 1,000 field discoveries in the country, only 35% are producing, and major oil has shifted its focus offshore.  Despite the large reserve and production base, Nigeria has struggled to develop a domestic oil industry.  Oil and gas production generates 80% of government revenue and 95% of Nigerian foreign trade.  The government is motivated to increase production and therefore revenues, and has a stated target of 4 millionbbls/d.

Nigeria’s marginal field program was initiated in 2001 to drive growth of a domestic oil industry.  In 2003, 24 fields were allocated to locally owned firms.  The operators of these fields enjoy lower royalties (paid both to government and original field owners) and lower profit tax.  Competition for these assets is relatively low, as they are only available to indigenous firms, or foreign firms operating in partnership with indigenous companies.  Umusadege has been one of Nigeria’s best performing fields in the program.  Approximately 130 fields were originally identified for the program, and the government intends to release another tranche of fields in the coming year.  

The Niger Delta used to see regular attacks on oilfield production, but the majority of this activity subsided 4 – 5 years ago.  Currently the main risk to production is siphoning of oil from export pipelines, causing lower production, revenues, and cash flows.  Pipeline losses are part of doing business in country, and companies and analysts take this into account in their estimates.  

The northern region of Nigeria continues to suffer from violent attacks by the Islamist terrorist group, the Boko Haram, which started in 2009.  The conflict is religious, and to date has been confined to the Northeast region of Nigeria, away from the business and economic center of the country, Lagos, as well as the oil producing Delta region.  Nigerian experts D3 has consulted with, including local businesspeople, and media reports suggest that the violence will remain confined to the North.  However, as the South becomes more and more prosperous and the North continues to struggle with poverty and lack of education and services, larger problems could emerge.


This article includes discussion of a company or companies in which The D3 Family Funds has significant publicly disclosed investments. As investors in the Funds, the principals of Nierenberg Investment Management Company (“NIMCO”) have personal financial interests in the value of those investments. This article is for informational purposes and to contribute to a general discussion about value investing generally. None of The D3 Family Funds, NIMCO or David Nierenberg is soliciting any investment in the Funds or in any of The D3 Family Funds’ portfolio companies.

The statements contained in this article with respect to specific companies and general market and economic conditions are based either on publicly-available information or on the internal analyses of NIMCO, reflecting its own subjective judgments at a particular moment in time.  We undertake no duty to update any information.  None of The D3 Family Funds, NIMCO or any of its directors, officers or employees assumes any responsibility for the accuracy of the public information relied on nor the correctness of its analyses and judgments. Those statements are not intended as investment advice to, and should not be relied on by, you or any other investor or prospective investor. To the extent those statements reflect assessments of possible future developments, those assessments are forward-looking statements and, as such, are inherently subject to the uncertainties associated with all assessments of future events.  Actual developments may materially differ as a result of circumstances affecting any specific company that is discussed, including developments related individually to that company or its industry as well as market conditions and the economic environment. Important information about the public companies identified in this presentation and the accompanying remarks—including information about their businesses, operations, financial results, risks and other matters-- can be found at

1 comment:

  1. I've held Mart for a couple of years now, and most of what you say is absolutely right. The only points I would clarify are:

    1. Mart is entitled to only 50% of production, so when the Umusadege field is producting 30,000 barrels, Mart will be reporting production of approximately 50% of the total production.

    2. Similarly, Mart reserves are reported as half of total Umusadege field reserves (which will go up when calculated in 2014 due to addition of UMU-10 and UMU-11).

    3. Unfortunately the generous Marginal Field tax savings will expire at the end of 2013. Mart and its partners really lost out by not being able to ramp production in 2013 as delays in the new Umugini pipeline and problems on the AGIP pipeline (losses, down-time, allocation limitations) have prevented the partners from really building their cash in 2013. Taxes in 2014 will go up, but it is hard to know how much at this point. Whether Nigeria will pass their Petroleum Bill timely enough to provide lower taxes in 2014 is unclear.