2018 was a tough year for the oil & gas specialist Riverstone Energy (LON: RSE) with the collapse in the commodity prices in the fourth quarter sending the NAV down 13.2% over the 12 months. The oil price has bounced back strongly since then with a rise of around 20%, yet the shares have continued to weaken, which suggests that the fund could be significantly undervalued.
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Riverstone Energyhas a unique mandate amongst the UK-listed investment trusts and is almost entirely focused on the exploration & production sector. The £1.4bn fund invests in companies that have management teams with proven track records that they have successfully worked with before and has gradually built up a concentrated portfolio of 14 holdings, most of which are unquoted.
Almost all of the fall in the NAV last year occurred during the fourth quarter and was mostly attributable to the reduction in the carrying value of two of its largest positions: Hammerhead and Centennial.
The manager says that the decline was partly driven by the macro environment, which was particularly challenging in Canada – thereby affecting Hammerhead and two of the other smaller holdings − as oil differentials widened materially and peer trading multiples declined even further than the US market. Centennial Resource Development (NSDQ:CDEV), which is traded on NASDAQ, was marked down sharply due to the fall in its share price.
The shares are trading on a 23% discount
On February 26 Centennial suffered a further 22% reduction in its market value following badly received results that prioritised balance sheet protection over production growth. This means that it is down around 11% year-to-date. Numis estimate that the fund’s NAV is therefore about $17.72, which implies that the shares are trading on a 23% discount.
Riverstone’s strategy is to focus on the long-term and invest in companies with attributes that are able to withstand the commodity price cycles. During the last financial year it concentrated on meeting its funding commitments for its existing investments and did not make any new acquisitions. There were also several full and partial realisations that contributed to a year end cash pile of $137m that is estimated to have increased to $208m following the latest transactions.
As the portfolio matures and the pace of realisations increases, the fund will look to reinvest in opportunities that span the entire energy chain, which should result in a reduction in exposure to the exploration & production sector. The upshot should be greater diversification and more holdings in assets with a shorter duration.
20% incentive fee
One of the main reservations with the fund is the 20% incentive fee that is calculated on an asset by asset basis and the tax liability on gains made on US investments, although this is now lower than it was in the past. These will dilute the returns to investors, but are more than compensated by the wide discount to NAV of 23%.
The Board is determined to tackle the discount and last November they tried a reverse auction tender for 5.4% of the share capital that cleared at the lower end of the price range. This enabled them to return £55m and added 1.5% to the NAV.
Riverstone is a highly specialist and unique investment trust that is yet to reflect the 20% recovery in the oil price that has taken place since the start of the year. Long-term, risk tolerant investors may well find that this is a decent buying opportunity.