SEC Info - United Heritage Corp - 8-K - For 5/5/03
... A reserve study of "remaining in place" gas on the Cato San Andreas Unit.
 
The active water flood at  the Cockrell Ranch unit is projected to increase proven reserves by 4.2 million BOE.  Cano Petroleum also has six additional mini-floods planned for 2010 and beyond to further exploit their Panhandle properties. The Cato field also has significant productive acreage (PUD, probable, possible reserves) that has yet to be exploited.
 
Cano presently has approximately 46.1 million shares outstanding with 22% owned by insiders and 63% by institutions.  The average daily trading volume is approximately 400,000 shares.  Reviews of the company's past few months of SEC filings reveal there have been many insider "buys".  Specifically, 22 insider "buy" transactions have occurred since November 2008 and no insider "sell" transactions.  As with many small cap energy "plays," Cano Petroleum's current share price has declined substantially from its highs.  Nevertheless, oil will continue to be for many years, the hydrocarbon that drives the global economy.  I recently utilized the Oil & Gas Confidential Website (www.oilandgasconfidential.com) to perform the following screen against 98 independent energy companies listed.  The aggressive energy movers of the future may likely be among those independent energy firms that are nimble and meet the criteria laid out below:  
 
1.      Small/mid cap/large "oil" focused energy producing companies with strong growth prospects (not    offshore, oil sands, natural gas producers, large integrated oil companies or national oil companies).
 
2.      Leveraged to substantially grow daily production and reserves over the next several years.
 
3.      Trades on a respectable, senior exchange (e.g. AMEX, NYSE, NASDAQ, TSX).
 
4.      Daily average volume of at least 300,000. Preferably a robust insider ownership stake.
 
5.      Debt to equity ratio of 0.60 or less.  Preferably a credit facility in place to meet future growth and cash flow positive.
 
6.      Preferably an effective hedging program in place for 2009/2010 to weather the economic storm.
 
7.      Trading at a discount to book value, proven reserves, enterprise value ratios, and/or other applicable valuation metric.
 
It turns out that it's a difficult list for most companies to satisfy.  Many are unable to grow production and reserves appreciably, if at all.  This is not surprising given diminishing oil discoveries and growing depletion rates. Several either trade on a bulletin board exchange or have insufficient trading volume which creates undue risk.  Others stumbled over the debt criteria or have no hedges in place to protect them during the current soft oil pricing environment.  Denbury Resources (NYSE: DNR) and Apache Corp (NYSE: APA) are a couple of stand-outs, though they are trading above their book value at present (Apache is un-hedged).  Cano Petroleum, though much smaller and relatively riskier (explored below) met all of the criteria. Obviously, these listed items are not the only elements one considers when choosing an investment, but they contribute to the due diligence process.
 
Cano Petroleum is led by Jeff Johnson who has been the founding CEO since 2004.  Mr. Johnson possesses 19 years experience in the energy field having provided investment banking expertise to Cheasapeake Energy (NYSE: CHK) and guiding his first energy start-up, Scope Operating Inc,  to a success where he had the good fortune to drill 30 consecutive, successful gas wells, then selling the company at the peak of the oil/natural gas cycle in the 1990s.  He owns approximately 1.6 million of Cano's shares (3.4% stake) and has been a consistent "buyer" of Cano shares on the open market, even as the price declined.  The Oil & Gas Financial Journal interview of Mr. Johnson provides some insight into his philosophy and outlook.
 
Cano Turning Legacy Assets Into Gold
OIL & GAS FINANCIAL JOURNAL
July 2007 

 
Risk & Reward Profile 

Every investment bears risk and it comes in all forms.  Cano Petroleum has a limited operating history (since 2004) and while one could argue its small size provides a platform for exponential growth, it can be equally argued that small cap firms are by nature riskier.  On the plus side, Cano mitigates some of this risk through its "business model".  Extracting oil from mature oil fields through proven water flooding technology is one such way Cano reduces its operating risks.  It is evident Cano has done their homework.  They acquired a patchwork of oil fields in well known, mature reservoirs at below $1.00 BOE (e.g. last acquisition of 1.9 million proven reserves for $0.48/BOE).  Part of Cano's success in acquiring assets at such a low cost  is that several of the oil fields in the Panhandle are owned by ranchers, farmers or low cost operators, some who would rather part with their depleting oil field than spend the capital necessary for secondary recovery.  
 
Cano's Panhandle properties exploit high quality oil (40 API) from the shallow brown dolomite formation and the Cato oil field is located in the prolific, historic San Andres formation.  Much is known about the geology of these oil fields given the plethora of well log data, geological mapping, pilots, and analogue water floods results in adjacent and surrounding fields.  Cano Petroleum's exploitation of mature reservoirs and focus on the right type of "rock" amenable to secondary oil recovery is the central theme of their business model.   
 
At present, Cano's water flood project at their Panhandle property has already provided a positive response as parts of the reservoir is returning very promising oil cuts (i.e. 4 - 10%).  While there is no exploration/discovery risk and very little geopolitical risk given all of these assets are in the U.S., secondary "water flood" recovery is by its nature a more capital intensive process than the primary method of extraction.  It should be noted that the cost of extracting oil through a "water flood" is typically not as expensive as an oil sand, shale or an off-shore project.   It can take somewhat longer for the economics of a secondary recovery project to be optimized.  Fortunately, Cano Petroleum's major water flood projects got underway back in 2007 and are now entering the production phase, with lease operating costs (LOE) projected to decline in 2009 as economies of scale are realized (source: Cano's 11/11/08 earnings call).
 
One of Cano's potential rewards is its ability to draw upon an inventory of oil field assets.  At present, the company has 51 million barrels of proven reserves, with a probable/possible resource base of approximately 149 million BOE.  Cano has only exploited approximately 1500 acres of the 9000 productive acreage at their major water flood site located in the Panhandle of Texas and even less at other oil properties.  Cano's 3rd party reserve engineers (Miller & Lents, Ltd.) have been exceptionally conservative in the assignment of reserves.  For example, the Panhandle PUD reserves are based on an 8% recoverable rate, though an adjacent water flood (i.e. the East Schafer oil field) delivered a 15% recoverable rate (source: Cano Petroleum Investor Presentation, July 2008). 
 
A risk to consider would be the operational execution of the water floods.  Such risks are mitigated by having experienced people designing and managing the water flood and buying attractive oil field prospects in areas where secondary recovery has been successful.   Pat McKinney, Cano's Vice President of Operations, has a proven track record in executing successful water floods (i.e. Wilmington oil field).  The water flood at Cano's Panhandle oil field is progressing well as parts of the field are presently seeing oil cuts as water is sweeping oil to the producing wells. Water floods at Cano's Cato and Desdomona oil fields are also continuing to progress.
 
In March of 2006, a brisk 60 mph wind storm blew through the Texas Panhandle and based on news reports, snapped electrical lines which triggered the state's largest wild fires.  Since part of this area is also oil country, four oil operators were subjected to claims that they were responsible allegedly due to inadequate electrical wiring.  There has been no finding that the fire was not started by a freak wind storm.  Several property damage lawsuits were filed against Cano Petroleum.  The first lawsuit resulted in a summary judgment in favor of Cano and was dismissed.  Other cases have been resolved through settlement agreements.  One case remains. The period to file additional wild fire related law suits expired in March, 2008.  It's unfortunate for Cano to have been pulled into this litigation and in my view they are managing it well (see recent 8K SEC filings of settlements and Cano Petroleum's most recent 10Q for full disclosure of all "Commitments & Contingencies).
 
10-Q Quarterly Report
Full Filing at EDGAR Online

Another risk factor applicable to all energy companies is their debt levels and the availability of credit.  Cano has a relatively low debt ($30 million at present) to equity ($150 million) ratio of 0.20.  For a few years now, Cano has enjoyed a strong relationship with its banking partner, Union Bank of California and recently its $120 million Credit Agreement was extended thru 2012.  Cano's borrowing base is $60 million.  UnionBankCal Equities also provides to Cano a $25 million Subordinated Credit facility.  Being in the early stages of their water flood projects, Cano Petroleum's operating income and cash flow has ample room to grow.  As of their last quarterly report (i.e. 9/30/08), Cano's reported total cash inflows of $11,455,000.  From an operating cash flow perspective, Cano has averaged $4.65 million over the past 4 quarters.  Cano has also taken some positive steps recently in reducing their total "Convertible Preferred Stock" from 49,378 to 26,430 which further strengthens their balance sheet.  Form 8-K.  Full Filing at EDGAR Online.
 

Valuation Metrics 

Unlike bulletin board (OTC) companies that have few filing requirements or very large companies that are multiple levels removed from most investors, Cano Petroleum offers a refreshing degree of transparency.  It trades on the American Stock Exchange and therefore must meet SEC filing requirements.  And being a small emerging company, it is not difficult to dialogue with management.  Their operational updates are straightforward and detailed.  This level of transparency helps in assessing risks, understanding operational progress and also facilitates the assessment of what the company may be worth.
 
Upon reviewing Cano's financial documents, it is very clear the company current share price (0.50 at the time of this writing) is far below its book value as determined thru its most recent 10Q.  Cano's total shareholder equity is $150.3 million.  The total number of outstanding shares is 46.1 million.  This brings the book value to $3.26 per share.  Book value is one metric used in establishing the acquisition value of oil & gas companies.  It tends to be a conservative method in assigning value given that it ignores price appreciation due to inflation (e.g. rising oil prices).
 
Another way of valuing an energy company is based on the amount of its proven reserves.  Cano Petroleum's reserve engineers, Miller & Lents, have designated 11.1 million barrels of oil equivalent (BOE) to the proven developed producing category and 39.5 million to the proven undeveloped category.  Using a conservative, blended (for PDP/PUD) in-ground value of $4.80/bbl (equivalent to 12% at a current WTI price of $40/bbl), Cano's oil assets may be worth $242.8 million (in-ground value)...considerably more than its book value.  If you take into account Cano's current assets and liabilities including its debt (from 9/30/2008 10Q), we arrive at approximately $186 million in net assets or an inferred value of $4.05 per share.  If oil prices rise or total reserves increase, the reserve value will also increase. 
 
A third valuation metric is the company's enterprise value as a ratio to its proven reserves or daily production as compared against its peers. In this regard, again Cano Petroleum is clearly exceptionally undervalued when compared against 15 of its peers (source: Cano Petroleum Jan 2009 Shareholder Presentation).  It should be noted that none of these valuation methods assign any value to Cano Petroleum's probable/possible reserves (i.e. 149 million BOE).  Ultimately, it's the market that assigns value to a public company's tradable stock.

 
Closing Comments

When you put it all together, you have a small energy company whose greatest growth years may still be unfolding.  The company operates in the United States and extracts primarily oil from mature basins.  There is essentially no exploration risk.  The leadership team has done an excellent job of acquiring oil assets adjacent to analogue fields that have been successfully exploited through water flooding.  Cano Petroleum's largest water flood is well underway.  There have been 22 insider "buy" transactions since November 2008.  Institutions known for a buy and hold strategy (Carlson Capital, Wellington Management, Trapeze Capital Corporation, etc.) control large blocks of Cano's outstanding shares.  By all measures, the company is significantly undervalued.  In my view, when one merges these facts with the prospect of oil prices increasing in the future, you are left with an intriguing investment opportunity.

 
 
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