Energy specialist Steve Smith runs a concentrated portfolio within the $50.4- million Norrep Energy Class and often allows single holdings to approach 10% of the fund. Careful about the entry point for each stock, he's equally focused on when to sell it.
"The traditional trigger point is when a stock is overvalued," says Smith, chief financial officer at Calgary-based Hesperian Capital Management Ltd. "It could be due to market enthusiasm, or the underlying fundamentals may have deteriorated. If we have conviction on the company's deterioration we may even short the position."
Currently, the fund is about 87% long, 10% short (or 77% net long) plus about 13% cash. Smith can be up to 20% short, and reached that level early this year. "The reason for raising the short weight would be the sector itself, not the companies," he says. "There is seasonality to the Canadian energy sector. Activity is high in winter and summer and low in spring and fall. The spring break-up is the traditional low ebb of the year."
Smith believed that gas producers were overvalued in the spring of 2013, a recurrence of what happened in April 2012. "Investors got a little too enthusiastic about gas stocks and saw the gas prices come off the bottom," he says. "We thought it was a 'faint hope' rally."
Take, for instance, Surge Energy Services Inc. SGY, a natural-gas producer that Smith held last year. "We saw production coming off quicker than most people expected. After we met with management we came away thinking this should not be a top holding -- and it went from top 10 to zero." Shortly afterward, the stock was punished when management revised its guidance.
Today, following a management change, Surge Energy is back in the portfolio. "We are quite happy with it -- and with our sell decision, too," says Smith, noting that the stock is a 5.4% holding.
The son of a Canadian Forces pilot who later flew jets for Air Canada, Smith is an accountant by profession who went into the oil industry and later ended up on the buy side of the investment business. Born in Zweibrucken, Germany, and raised in Montreal, he earned a science diploma from Loyola College and in 1978 completed a bachelor of arts in English literature at the University of Western Ontario.
Smith decided to pursue an interest in accountancy and earned accountancy credits from Wilfrid Laurier University. After a brief stint with KPMG in London, Ont., he moved to its Calgary office in 1981 and received his chartered-accountant (CA) designation in 1983. Then he jumped ship and was hired as controller at Canadian Pioneer Petroleum Ltd.
"I spent 12 years in the industry but all these companies got taken out," recalls Smith, adding that he left the firm to join Poco Petroleums Ltd., where he stayed for five and a half years. When Poco was caught in the 1987 market crash, Smith shifted into a consulting/vice-president role and worked for companies such as Petrolia Oil & Gas Ltd.
Between 1995 and 1999, Smith was a retail analyst at BMO Nesbitt Burns, where he focused on small-cap energy stocks. Later, he joined Yorkton Securities, which later evolved into Macquarie Capital. He stayed until 2005, along the way developing a reputation as a top North American energy analyst.
After several years as a sell-side analyst at First Energy Ltd., Smith joined Hesperian Capital in 2007, working on its flow-through business.
In May 2009, the firm launched Norrep Resource Class. In 2012 the name was changed to reflect its exclusive exposure to oil and gas stocks. For the 12 months ended Sept. 30, the Morningstar 5-star-rated fund returned 16.4%, versus a median loss of 4.7% in the Natural Resources Equity category. Over the last three years, the fund again outperformed handily with an annualized 10.7% return, compared with a 7% loss for the category median.
Smith likes to focus on the inefficiencies in the market, since many investors lack the skills of evaluating the complexities of oil and gas companies. "Most people don't understand the difference between resource and reserves, for instance," says Smith, adding that he focuses on cash-flow multiples to value stocks. Smith also notes that his role has changed from trying to anticipate market trends. "Now that I'm on the buy side, I have to 'anticipate the anticipation.'"
For instance, when Malaysia-based PetroNas acquired Progress Energy Ltd. many sell-side analysts focused on Progress's neighbours, such as Painted Pony Petroleum Ltd. PPY.
Instead, Smith focused on service companies, which have dramatically outperformed explorers since the acquisition. "Eventually it would dawn on the analysts to talk about the service companies because it was going to be pretty good up there with all that money being spent." But Smith was ahead of the game, holding service providers such as Secure Energy Services Inc. SES.
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