Monday, January 04, 2016

Madalena Energy Drills Where It Chills

Madalena Energy (Canadian ticker MDN.V, US ticker MDLNF) caught my eye back in 2014. They're based in Canada and they drill for oil and gas there too, but they also drill in Argentina. I have long been skeptical of the chances for junior exploration companies who locate their offices in North America but chase properties in developing countries. Raising capital in the easiest markets isn't the same as successfully drilling in difficult markets.

I always check the company's management team first. The current CEO was educated as a petroleum engineer but spent a lot of time in consulting and investment banking. I usually like it when company leaders have degrees in their sector but successful field work has to flesh that out. Companies in the business of finding and pumping oil must have leaders who have successfully done that for their entire careers. I am similarly unimpressed with other senior team members who had undefined positions with other companies, some of which no longer exist. I can't judge their abilities if I don't know what they did or why their former employer isn't around anymore.

The company's four Canadian properties must get pretty darn cold in the winter. Three of them are producing. The Argentina properties are a slightly different story. Some of the properties appear to be in production but it's hard to tell from the website's descriptions. I did not find any NI 51-101 reports anywhere on the Madalena Energy website, so it is impossible for me to verify each property's potential.

Geopolitical risk is always worth noting. Canada ranks 10th on Transparency International's Corruption Perceptions Index and 6th on the Heritage Foundation's Index of Economic Freedom. Meanwhile, Argentina ranks 107th for corruption and 169th for economic freedom. That is a huge delta in risk for investors from other countries. Argentina may start moving in the right direction after its recent political changes. International investors will be watching for progress.

I downloaded Madalena's quarterly financial statements and MD+A dated September 30, 2015. There's no pretty picture here. The accumulated deficit in shareholder's equity (or what we Americans typically call negative retained earnings) is now at -CAD$115M. Inexperienced investors need to recognize this type of negative figure as the amount of invested capital earlier investors have put into a company that has not yet earned it back. The company has $11M in cash on hand and swung to a $14M profit after losing money in much of 2014, so they are above what would otherwise be a burn rate for now.

The weakness of Canadian and Argentinian currencies against the US dollar probably helps this company's bottom line. Argentina recently relaxed its currency controls, devaluing the Argentinian peso against the US dollar. Note 2 in the company's quarterly financial statement says their Argentinian invoices have been in US dollars and their planned capex for Argentina is weighted to US dollar denominated expenditures. Argentina's currency devaluation means financing in US dollars and spending against a falling Argentinian peso will make Madalena's capex in the country less expensive. This is good news given the company's negative free cash flow for most of 2015.

Madalena deserves kudos for actually producing oil and gas, something many junior resource companies never do. The company's fortunes in Argentina may improve if the new government there takes reform seriously. One big problem facing the entire oil and gas sector is the continuing weakness in world oil prices. Bearish oil markets will challenge Madalena's ability to sustain the success it experienced in late 2015.

Full disclosure: No position in Madalena Energy at this time.