BULLETIN #142 – FEBRUARY 1 2014

COMPANY ANALYSIS

MANITOK ENERGY MEI-TSX; MKRYF-PINK

Manitok is a very intriguing energy stock, here in early 2014, for several reasons:

1. The stock dropped by one-third as the company bought a new asset (and hired a new geological team to run it), and replaced the COO. Both moves were a surprise to the Market.

2. Even before the Canadian dollar dropped and natural gas prices rose, Manitok was drilling wells that paid out in 8-10 months (under 24 months is good).

3. The Canadian dollar dropped and natural gas prices rose—giving companies with a 40% gas weighting like Manitok a huge cash flow lift

4. A new play in Southeast Alberta is emerging in channels in rocks called

“glauconite”—Manitok’s new big land package, a Joint Venture (JV) with

Encana, has a lot of exposure to that play.

Manitok has wells in two new areas—Entice and Quirk Creek—that could open up

a lot of new locations and have a positive impact on valuation if successful.

QUICK FACTS

Trading Symbols: MEI-TSX; MKRYF-PINK Share Price: $2.29 Current Production: 5,550 boe per day (58% oil and liquids) Basic Shares Outstanding: 74.5 million Market Cap: $171.3 million Net Debt: $35 million Enterprise Value (EV): $206.3 million Estimated 2013 Cash Flow: $41 million EV / Cash Flow: 5.03 times EV / Flowing Barrel: $37,117 http://www.manitokenergy.com/

POSITIVES

-clean balance sheet – among the least levered of all junior producers -highly economic, fast payout wells -decline rates that are much lower than resource play wells -rock bottom valuation -Entice area could be large catalyst--provides huge exposure to large oil in place -huge leverage to a rebound in natural gas prices

NEGATIVES

-there is exploration risk on every well being drilled, even the Entice property

lacks low-risk repeatability at this time -Entice acquisition means a heavy three year capital spending program -departure of key technical person creates uncertainty -it will take time to win back investor trust after unexpected strategy change

BACKGROUND

Manitok went public in 2010 with a refreshingly contrarian strategy. The company was put together with a focus on returning to the Alberta Foothills region to explore for conventional oil and gas pools. This was at a time when the majors and large independents operating there were fleeing the area in search of repeatable horizontal plays out in the plains to the east. As the industry was zigging, Manitok zagged. That allowed Manitok to amass its Foothills acreage in 2010 at land prices that had not been seen since 1998 when oil prices were under $20 per barrel. And there’s a lot of oil and gas infrastructure there too—making economics a lot better. Years ago, when the majors drilled up this Foothills region they targeted the largest “big home run” pools and bypassed smaller pools—but ones big enough to move the needle for a small company like Manitok.

Most importantly, the company brought in a technical team that had A LOT of success in the Foothills for Talisman Energy--over a 10 year period this team had executed a $3 billion capital program involving hundreds of wells in there. Not only were they good, but they knew specifically where oil and gas pools had been left behind by the industry. They knew where the left over low hanging fruit was. And they were right.

Manitok has gone from basically zero in 2010 to over 5,500 boe/day at the end of 2013 with a 75% success rate. The contrarian strategy worked like a charm. But not everything was great. Despite this steady record of success the market was lukewarm to the shares of Manitok--the company has always had one of the lowest valuation multiples in the entire energy sector. Growing production and cash flows drove the share price higher, but valuation assigned to cash flow and production never expanded. What the market didn’t like about Manitok (despite its success) was:

1. no big drilling inventory like a shale play 2. no obvious buyer for the company because of that

Sadly for shareholders, while Manitok has been incredibly successful with its wells, the Street prefers the near 100% success rate of wells in a horizontal resource play. Fed up with a discounted valuation that was seemingly going to be permanent, CEO Massimo Geremia took action—in a way that surprised the Market. That action involved Geremia showing Chief Operating Officer Tim DeFreitas the door. That move got the attention (concerns) of shareholders as the Foothills is a very technical play, and the perception was that DeFreitas had done very well as Manitok’s chief technical man. Then the company further shocked shareholders by announcing a joint venture with Encana that was a 90 degree turn for shareholders. This abrupt change shocked loyal shareholders who had bought into the original Manitok business strategy. Overnight Manitok had switched gears and lost a man that investors thought was key to the company’s prior two years of successful growth. So the stock sold off 30% in a hurry. I understand the selloff in the stock. But it’s important to note that just because this change of direction was unexpected doesn’t mean that it is a bad idea. Investors who sold off Manitok’s shares may very well have taken a shoot first, ask questions later strategy. Manitok’s management’s intention with the strategy change is to try to remove a persistent valuation discount. If the new team—which is a larger, expanded team with several VPs now (every company needs that at some point in their growth curve) can prove up the new property (Entice) then the stock could get on a roll again.

PROPERTIES Property 1 – Alberta Foothills The last big drilling in the foothills that took place was done by majors who were looking for gas when it was worth more than oil.

Then the shale revolution hit and everyone went after Cardium, Viking, Shaunavon etc. tight oil plays. The land acquired by Manitok has some but not a lot of well control (that’s the industry term that means old wells/logs they could look at, learn from to lower risk). Manitok was definitely thinking outside the box by amassing this play. And it was dirt cheap—they were able to buy 200,000 acres for what we in Canada say is “a bag of pucks”.

While Manitok spent its first couple of years targeting oily Cardium locations—because of the better economics--be aware that the company has many more times the opportunity in liquids rich gas areas of the Cardium and Mannville than it does for oil. So if this January 2014 rebound in natural gas prices holds, Manitok has a lot of leverage to it. Manitok is targeting natural fractures in the Alberta foothills that can be consistently targeted through an understanding of the geological structure of the reservoir. Production out of these pressured foothills fractures can be very high by WCSB (Western Canadian Sedimentary Basin) standards and these wells can decline at lower rates than a resource play/tight oil well which leads to shorter paybacks—so GREAT economics—when they hit.

Where a resource play well declines by 65% to 80% in the first year, a Foothills well drilled into a conventional reservoir decline by roughly 40% in year one and then 25% per year after that. Additionally these Foothills wells have much higher EURs (Estimated Ultimate Recoveries) of 200,000 to 1.2 million barrels which—at the high end--is much greater than what a resource play well would have. The NPV10 (Net Present Value discounted at 10% pa—think of this roughly as the cash flow after the well is paid back) of a good well can be over $20 million—and potentially a lot more. Spend $5 million, get $20 million. A huge tight oil well in the North Dakota Bakken might have $10 million NPV10 on a $10 million cost. The deeper Duvernay formation in Canada that is now getting all the attention—same. $10/$10 Manitok’s first target area in the Foothills was an area called Stolberg. This play has been a huge winner for the company. Total production from the Stolberg pool since 2012 is over 1.1 million boe.

If you’ve ever been in mining, think of these old style conventional pools of oil like a high grade underground mine. You only ever have 2-3 years of reserves in front of you, but you produce them for decades (sometimes centuries!). That’s what Stolberg is for Manitok. Every year, for the last 3 years, CEO Mass Geremia tells me he has 20 future drilling locations at Stolberg—meaning that they find new pools, or extensions of existing pools, every year to replace the ones they just successfully drilled. Right now Geremia tells me they have roughly 18-26 wells left at Stollberg and will be drilling there through 2015. After primary drilling, the next stage will be water-flooding the pool. Initial reservoir modeling suggests it may be possible to double the recovery factor in the field from 9% to as much as 20%.

Manitok has a second Foothills target area at Brown Creek which is a look alike to Stolberg--10 sections there, but Manitok only has a 25% working interest. So far success at Stolberg has put Brown Creek on the backburner. Property 2 – Quirk Creek

In July of 2013 Manitok announced a farm-in with Legacy Oil and Gas (LEG-TSX) in Quirk Creek in SW Alberta. The farm-in is on about 21 gross sections (13,440 acres) of land, with about 19.6 gross sections (12,544 acres) being prospective for sweet Cardium oil. The first Cardium farm-in well was encouraging, testing at 200 bbls/day of light oil. Manitok believes that there is potential for 6 million barrels per section, over at least 14 sections, and have over 15 drilling locations if the play is successful. Manitok is now drilling the second well at Quirk Creek. Drilling the first two wells gave Manitok a 70% interest in 14 of the sections of land. One additional well (Manitok pays 100%) gives the company a 70% interest in the remaining 5.6 sections. The plan is to produce the first two wells for two to four months before deciding on whether to drill additional wells. Property 3 – Entice Alberta The addition of Entice gives Manitok a second core area that could have lots of running room. The agreement with Encana involves Manitok acquiring a net 98,893 acres in the Entice area of Southeast Alberta. The lands are checkerboard—offsetting sections—but all in the same area. This reduces the both the capital cost involved and subsequent operating costs once production begins. There have been roughly 250 wells drilled to the depth of the Mannville (~1500 to 1800 meters) on this property—the industry calls that having excellent “well control”. You know what you’re going to get! These logs combined with 3D

seismic have allowed Manitok to identify undeveloped opportunities in the Viking, Upper Mannville, Glauconitic, Ellerslie, Pekisko and Nisku formations. As that list of prospective zones suggests, the Entice Area has multi-stacked pay and Manitok will be able to test multiple zones with each wellbore. This reduces drilling risk as well as cost. The Glauconitic channel sands—where the oil is trapped in a channel that meanders underground like a river bed channel—is getting a lot of attention right now from nearby players like Blackspur (private) and Cardinal (CJ-TSX) and Hemisphere (HME-TSXv). The capital costs of drilling in the area are considerably less than in the foothills, with all-in well costs generally ranging from $1.0 million to $3.0 million depending on the depth drilled (foothills wells are roughly $5M). Manitok believes that existing 3D seismic on the property by itself has a replacement value of more than $40 million and that there are 55 log leads on potential oil pools from the wells previously drilled.

Each log lead has a potential oil pool of 500,000 to 8 million barrels. In total Manitok believes that there could be up to 180 million barrels of recoverable oil on the property. The slide above shows the dense drilling in the Mannville to the east of this land right up to the edge of it. The area itself has had over 200 million barrels of oil and 12 trillion cubic feet of gas production. PanCanadian was the company that drilled up this area and was heading west to drill the newly acquired Manitok blocks when the merger with Alberta Energy to form Encana happened. With Encana being more focused on trying to find big gas reserves the drilling of this land never took place. The play clearly has great potential but there are two concerns. The first (which I’ve mentioned several times) is that like the Foothills, this is not a resource play with virtual certainty of each well being a producer. There is exploration risk here. The other thing to be aware of is that the company has to perform quite aggressively now. After paying $16 million for the right to drill it, Manitok has to spend $100 million over three years here. If this property does not perform as expected, Manitok may have to renegotiate with Encana. $100 million is a lot of cash even over three years for Manitok, so these wells had better perform. I put this to Geremia, and he said: “All of our wells have to perform regardless of capital commitments otherwise our share price will plummet. I’m under that pressure to perform every day with every well. Entice is less risky than the foothills. I feel more comfortable spending $100 million at Entice than I do spending $100 million anywhere else in the basin. We’re likely to spend $100 million per year for the next 3 years. That makes entice only about 33% of that spend. There are over 7 different play types on 4.5 net townships. Look at the drills in the surrounding lands and the success.”

Manitok has reprocessed 420 sections of 3D seismic that it received from Encana. Drilling will start in February 2014. Manitok expects it will initially be targeting Nisku, Ellerslie (Basal Quartz) and Glauconitic crude oil opportunities initially. The slide below shows the potential that Manitok thinks each zone has.

Bringing light oil up out of the ground for less than $30,000 a flowing barrel is very good! I’m guessing payback on the Glauc, Ellerslie and Nisku would be 9-13 months, and about 18-24 months on the Viking and Pekisko—which means they get developed later.

FINANCES / VALUATION Manitok looks cheap by any valuation method. Then again, it has looked cheap for virtually its entire existence as a company. The stock has risen as production has grown. But management wants a higher multiple, or valuation applied to this growing production. Full year 2013 cash flow guidance is for $41 million and exit production (which was already disclosed) was 5,550 barrels per day. With an enterprise value of $206 million that means that Manitok is trading at 5 times cash flow and $37,000 per flowing barrel (55% oil and liquids). For a company that has doubled production over the past two years that is very cheap. Shares could trade 50% higher tomorrow and still not look expensive. On 2014 guidance the company looks almost ridiculously valued. 2014 cash flow is expected to be $70 million and exit production guidance is 7,300 boe/d (68% oil and liquids). If I factor in 2014 year end debt of $70 million, Manitok will have an enterprise value at the current share price of $230 million. That means the company is trading at 3.28 times cash flow and $31,000 per flowing barrel.

The issue in buying Manitok now, however is that how solid is that 2014 guidance? Until Entice is proven—which is getting $34 million in drilling in 2014—that’s a Big If. Management says Entice should be more predictable, but still not like a tight oil resource play. What also makes Manitok’s low valuation look very appealing is the state of the balance sheet. At year end 2013 Manitok will have $30 million in debt and a cash flow run rate (based on exit rate production) of almost double that.

That makes Manitok one of the least levered (low debt) companies in the sector.

But again, one consideration that does not show up on the balance sheet though is the $106 million of drilling at Entice that Manitok has committed itself to over the next three years as part of the Encana JV. If the wells being drilled at Entice do not generate the cash flow that is expected, this pristine balance sheet could get turned upside down fairly quickly. So while this Entice play provides Manitok with some diversification and great opportunities, the company has also added a large financial commitment as well.

WHAT THE ANALYSTS SAY

FIRM TARGET PRICE Acumen Capital $4.25 Clarus Securities $3.75

Dundee Securities $4.00 GMP Securities $3.15 National Bank $4.00 Raymond James $2.00 RBC Dominion $3.50 TD Securities $3.00

STOCK CHART

CONCLUSION

I understand why shareholders decided to dump shares of Manitok on the abrupt change of direction.

The Entice acquisition—if it becomes successful—will help solve the problem of providing Manitok with a repeatable and predictable drilling inventory that will help garner a better valuation.

I’m waiting to see how Entice works before buying more stock. Yes, there was a curveball thrown at shareholders, but it could very well be that this Entice deal is a great one.

The other things I know are that Manitok has an excellent balance sheet and it trades at an extremely attractive price.

If Entice works (paybacks of 15 months or less), I see a high probability the stock gets re-rated upwards in the second half of 2014.