Paid To Wait For PNG Activity to Pick Up

High Arctic continues to offer a deep value opportunity for small cap investors.

Iain Butler ❯

Chief Investment Advisor, Motley Fool Canada Fool since November 2012 Iain Butler, CFA, is Lead Advisor on Discovery Canada 2017. He is also the Chief Investment Advisor for Motley Fool Canada and is the lead advisor on its flagship Stock Advisor Canada product. Before joining the Fool, Iain was a “buy-side” analyst and through this experience is well-versed in the idiosyncratic ways of the Canadian market. His investing interests are centred on scouring the market for interesting businesses that trade at reasonable prices and offer an appealing risk/reward relationship. Since joining the Fool in 2012, Iain dedicates each day to spreading Foolishness throughout this great country!

Published March 25, 2013 2:07 pm EDT

Last week, small cap energy service company High Arctic Energy Service (TSX:HWO) announced that it is increasing the monthly dividend from $0.01 to $0.0125, a 25% increase.

The increase takes the annual payment to $0.15 from $0.12 and brings the yield on the stock to 6.2%. With net cash of $13.6 million and 2012 free cash flow of $15 million, the annual cash requirement of $7.5 million to fund the dividend appears more than affordable.

Expect a pause

High Arctic was profiled here in early February and continues to offer solid long-term prospects, particularly for the bargain basement valuation affixed to the shares (P/E ratio of 4).

However, in the recently released quarterly results, management indicated that growth will be a struggle in 2013.

Low natural gas prices and crude oil transport bottlenecks are having a negative impact on the Western Canadian Sedimentary Basin (WCSB) and causing a slowdown for the company’s Canadian operations.

In addition, we can expect a temporary plateau in the company’s Papua New Guinea operations, which continue to offer compelling upside over the long-term. The company’s primary client, Oil Search Limited, is temporarily diverting financial resources towards completing an LNG facility in PNG and away from drilling. This dynamic should reverse once the LNG facility is complete. The project is on track for completion at the end of 2014.

No need to panic

Though subdued near-term drilling in PNG is expected, the company continues to expect growth from its equipment rental platform that it has established in the country. And, the eventual completion of the LNG export facility bodes well for activity levels in this highly undeveloped resource base.

Another consideration that was mentioned in the quarterly release was that the company is negotiating with Oil Search to extend the current service contract that expires at the end of 2013. A new contract will relieve one of the more significant risks involved with this story.

Solid prognosis

Given the stock’s current valuation, a slowdown in Canadian activity and a pause in PNG is priced in. If the company can keep printing results like the ones achieved in 2012, the multiple on this name will expand. Earnings growth is not required for a stock price to go up when it trades at a multiple of 4. Assuming nothing breaks in either the Canadian or PNG operations, a worst case scenario for this name is an affordable 6.2% yield as you wait for multiple expansion and earnings growth to take hold.

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Fool contributor Iain Butler does not own shares in any of the companies mentioned in this report at this time. The Motley Fool has no positions in the stocks mentioned above.