This popular oil company has become a speculative stock

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The collapse in the price of oil has hit many companies hard but few have been as battered as Long Run Exploration Ltd. This small Calgary-based producer had become popular among investors seeking a combination of growth potential plus steady cash flow (it paid a monthly dividend). With almost 200 million shares outstanding, the daily trading volume often exceeded one million shares.

The company owns a portfolio of assets in the Cardium, Viking, and Montney regions of Alberta, and was aiming to produce approximately 32,000 boe/d (barrels of oil equivalent per day) in 2014, weighted 51 per cent oil and 49 per cent gas. Long Run has more than 1.8 million acres of land, a large inventory of development opportunities, and $1.3-billion in available tax pools.

Until last September, the stock was very stable, trading in a range of $5 to $6 a share and yielding upwards of 7 per cent. The company's directors were so confident about the future that they raised the dividend in June.

Then the bottom fell out of the oil market and the price of Long Run shares plunged. By December, it was under $2, at which time it looked like an attractive takeover target. Now the price is in penny stock territory. Other energy stocks have lost value, but few have suffered to this extent. What went wrong?

Let's look at the numbers. Long Run released its fourth-quarter and year-end results in early March. Average daily production for 2014 came in slightly under the 32,000 boe/d target, at 31,168 boe/d. However, that was a 24-per-cent improvement over 2013.

The company increased its proved plus probable reserves in 2014 by 75 per cent to 170,625 MBoe from 97,683 MBoe in 2013 as a result of Deep Basin acquisitions and Long Run's 2014 drilling program. Of this, 6 per cent of the increase was attributable to growth in oil reserves. Reserves of natural gas liquids were up by 475 per cent, while natural gas reserves increased 86 per cent. Total proved reserves were up 65 per cent. The reserve life index (RLI) moved up 41 per cent to 14.4 years from 10.2 years in 2013. In short, this company owns some valuable assets.

That's the good news.

The bad news is the company lost $190.4-million ($1.21 per share) in 2014, compared to a profit of $24.3-million ($0.19 per share) the year before. Worse, the loss in the fourth quarter, when the bottom fell out of oil prices, was $258.6-million. That wiped out the gains made earlier in the year, and more. The company said "the loss resulted primarily from property impairments of $300-million after tax due to the decline in future commodity price forecasts at Dec. 31, 2014." That's not a good sign for 2015 with the price of oil likely to remain low for most or all of the year. Investors responded by dumping the stock.

The company's high debt load becomes especially worrisome in this context. Net debt increased from $452.2-million at the end of 2013 to $739.6-million on Dec. 31, 2014, mainly due to expenses relating to acquisitions. That's a jump of about 64 per cent, and it appears Long Run has just about maxed out its credit line. Management has made it a priority to reduce the amount by $100-million this year.

To do this, the company has suspended its dividend and scaled back its capital expenditures. Long Run is also targeting a 10-15-per-cent reduction in general and administrative expense and a 5-10-per-cent reduction in operating costs for the year. The company is actively seeking buyers for some of its non-core assets and says it is "continuing to evaluate our disposition opportunities to generate additional cash flow to improve our balance sheet". The problem is that selling assets in an environment where everyone else is doing the same is not usually a winning strategy. It's more like desperation.

LRE is also hedging a large part of its production to protect funds flow from further downside risk. For the first half of 2015, the company has hedged approximately 70 per cent of its oil production with an average price floor of WTI $79.69 (U.S.) per barrel and 55 per cent of its natural gas production with an average price floor of $3.46/gigajoule. Total hedged volumes for 2015 are approximately 55 per cent for both oil and natural gas.

Sprott Resources Corp, which hold a large position in LRE, said in a statement issued in March: "We support Long Run's management in these decisions and their objective of delivering sustainable long-term growth to investors." But how long that patience will last in the face of the persistent downward trend in the share price remains to be seen.

This has now become a "hope" stock, albeit not a hopeless one. The company is clearly in difficulty and will remain so until oil prices recover to more normal levels – in this case, at least $80 (U.S.) per barrel. Management is doing what it can to cut costs, in effect trying to keep LRE on life support until conditions improve.

The problem, of course, is that no one knows how long that will take. The way this drama is playing out, we could see cheap oil for the next two or three years, which could be enough to tip LRE and other companies like it into bankruptcy, if a white knight doesn't emerge with a takeover bid. In other words, there is a chance the stock could go to zero. It's currently near its all-time low and the chart looks terrible.

There are three ways to go at this point. Which you choose depends on your investment personality and risk tolerance.

Sit tight. If you own the stock, you've already taken a big hit. Most of the downside has already been realized so you may want to hang on and hope that the oil price recovers before the company runs out of money.

Sell. This is the "don't-throw-good-money-after-bad" approach. Salvage what you can – it's better than losing everything.

Buy. LRE does own real assets. It's not a fly-by-night exploration company with no resources. Those assets are worth something to somebody. Since they are now dirt cheap, we could see a takeover bid. Or perhaps all-out regional war in the Middle East will suddenly drive oil prices up. Either way, a speculator could make a lot of money.

I do not recommend speculative stocks as a rule and this is what LRE has become at this stage. Therefore, my advice if you're a shareholder is to sell and use the capital loss for a tax write-off. But if you're more comfortable with one of the other scenarios, go for it.