January 15, 2010

Daylight Resources Trust has just announced its 2010 guidance, Q1 distributions and provided a Q4 operational update.  We are becoming more and more confident in our thesis that Daylight is undervalued given its extensive holdings in several key regions and formations.  In particular, drill results from the Trust’s Pembina Cardium holdings, highlighted by a recent brokerage report published over the holidays, could be a positive catalyst in 2010.

Since the publication of this report, the market has become enamored with companies that hold certain specific resource plays.  Remember, a “resource play” is defined as a large, contiguous land base with a repeatable drilling inventory, low geologic risk and very attractive economics.  Happily, Daylight has large sections of land in three key geographic areas that are garnering significant attention. 

In the Pembina region, Daylight has exposure to Cardium oil, with over 100 net sections of land.  We expect drill results from their latest horizontal well when the results for fiscal 2009 are released on March 2, 2010.  The Trust also holds land in West Central Alberta that is prospective for the Bluesky, Cardium, Wilrich and Cretaceous formations.  Finally, Daylight’s Elmworth region covers over 200 net sections containing the Cadomin, Cretaceous, Montney and Nikanassin natural gas formations.  We believe that the market is just beginning to recognize the potential of the Trust’s inventory of projects.

According to the Trust’s update on January 12, 2010, Daylight has increased its 2010 capital budget to $300 million or $275 million net of Alberta Crown drilling credits, an increase of over 70% from 2009.  With the current asset base, Daylight expects to average 40,000 to 42,000 boe/d of production in 2010.  Exit production levels are expected to be greater than 42,000 boe/d, an increase of over 10% from the average production levels achieved in the fourth quarter of 2009.  Operating costs are expected to decline to a range of $10.50 to $11.00 per boe for 2010, compared to $11.80 over the first nine months of fiscal 2009.  With only $100 million drawn on the Trust’s $500 million credit facility, strategic acquisitions could potentially boost the average and exit production rates.

With tax pools of over $1.4 billion, we expect that Daylight will convert to a high-dividend paying corporation no later than the May 2010 Annual General Meeting.  Although the Trust has set its   Q1 distributions at $0.08 per month, we expect that the distribution will be reduced eventually, but not by more than 50%.  As long as Daylight’s management can continue to articulate a clear growth strategy, we believe that the market will reward them.

March 12, 2010

Daylight Resources Trust has just announced an arrangement agreement to acquire all of the outstanding shares of West Energy Limited.  The transaction is consistent with our investment thesis that Daylight’s management is building a much larger entity through a combination of organic growth and accretive acquisitions.  Importantly, the purchase consolidates the Trust’s existing position in the Pembina region of Central Alberta, adding over 100,000 net acres of undeveloped land and 40 net sections of Cardium oil rights.

The transaction is valued at approximately $570 million, including the assumption of $135 million of net debt.  Consideration is comprised of $115 million of cash, with the balance to be paid in Daylight units.  On a per share basis, each West stakeholder will receive either $5.50 in cash, 0.465 of a Daylight unit, or some combination thereof such that the total cash component does not exceed $115 million.  Currently, West Energy is trading at approximately $5.00 per share, an 18% premium to the average trading price over the ten days prior to the offer being made public.  Based on West’s recently released year-end documents, Daylight purchased the Company below its net asset value of $5.96 per share.

Assuming estimated land value of approximately $110 million, Daylight is paying $79,300 per flowing barrel and $23.84 per barrel of proven and probable reserves.  Although at first glance these multiple are not cheap, the price is relatively easy to justify.  West’s light oil production of 5,800 barrels per day generates operating netbacks of $38.26 per barrel at current commodity prices, which should deliver a 7% increase to Daylight.  It is the high netback per barrel relative to the price per barrel of proven and probable reserves that should allow the Trust to generate a solid economic return over time.  Additionally, the overlap of the land positions should allow a reduction in operating costs by sharing oil facilities and systems.  Finally, the complementary land base creates a large inventory of repeatable drilling opportunities.  Management now estimates an unrisked horizontal drilling inventory of 300 to 600 Cardium oil locations at Pembina.

We expect the transaction to close mid-to-late May, sometime after Daylight’s conversion to a corporation.  As we’ve discussed previously, investors should expect to receive a $0.05 dividend per month.  The combined entity will have over $1.7 billion of tax pools, which should be available to defer taxation into the future.  Eventually, Daylight could become one of the premier, mid-tier E&P companies in North America as they continue to grow production, reserves, cash flow and net asset value.

May 14, 2010

On May 6, 2010 at Daylight’s AGM, unitholders voted 99.7% in favour of the plan of arrangement to convert into a corporation.  Unitholders will receive one common share of Daylight Energy Limited for each unit of Daylight Resources Trust.  The Company’s common shares began trading on the Toronto Stock Exchange under the new symbol “DAY” on May 12, 2010.

Concurrently, on May 12, 2010, the Company’s purchase of West Energy Limited closed successfully.  This acquisition increased Daylight’s Cardium rights in Pembina to over 100 net sections and increased the Company’s oil and liquids weighting to approximately 45%.  Upon the closing, management updated guidance to include West’s forecasted contribution.  Although production currently totals 45,000 to 46,000 boe/d, official guidance calls for average annual production volumes of 43,000 to 44,000 boe/d.  The decline is due to the timing of the acquisition and some deferral of natural gas production in anticipation of higher prices later in 2010.  We are not concerned with the slight dip since we have seen Daylight’s management take a conservative approach to production guidance subsequent to an acquisition on several occasions.  In fact, the anticipated exit production rate is over 47,000 boe/d.

As part of the transition to a high yielding but growth-oriented corporation, Daylight’s distribution of $0.08 per unit per month was reduced to a monthly dividend of $0.05 per share per month.  Based on the Company’s success with the Pembina Cardium, the majority of the 2010 $300 million capital budget will be allocated to horizontal Cardium light oil wells.  Further, with the closing of the West acquisition, the Company’s credit facilities were expanded to $650 million with approximately $350 million drawn today.  Given the Company’s growth potential, we believe that Daylight is better off investing the funds in its own properties than continuing the prior level of distributions. Thankfully, management did an excellent job telegraphing the changes and we were pleased to see the market respond positively.  We look forward to watching Daylight exploit its asset base and eventually become one of the premier intermediate oil and gas companies in Canada.

July 16, 2010

Daylight Energy Limited has taken another step to concentrate its efforts on the development and exploitation of its repeatable, low risk and high netback resource plays.  The Company’s growth areas at Pembina, West Central Alberta and Elmworth in the Deep Basin remain at the core of the portfolio.  However, after the two key acquisitions of Highpine Oil and Gas Limited and West Energy Limited, Daylight has now sold some non-core assets in Eastern Alberta.

On June 30, the Company announced an agreement with the privately-held Gear Energy Limited to sell certain properties for total consideration of $125 million.  Proceeds consisted of $100 million in cash and $25 million of equity in Gear.  The asset package included areas known as Bonnyville, Halkirk, Lloydminster, Paradise, Sounding Lake, Vermillion and Wildmere.

In first quarter of 2010, these assets produced approximately 2,300 barrels of oil equivalent per day of mostly heavy oil.  At a price of $54,000 per flowing barrel, the transaction was inline with recent industry sales of conventional assets.  Because Daylight is trading roughly at this valuation, the asset sale is neutral on a dollar per flowing barrel basis.  However, because the proceeds will likely be redirected into higher netback opportunities, we believe that the transaction will be accretive to cash flow and net asset value over time.

Once the transaction closes, likely by the middle of July, proceeds will be used to reduce outstanding indebtedness under Daylight’s credit facilities.  However, with the additional balance sheet flexibility and no change to Daylight’s previously announced capital budget of $300 million, we expect management to eventually execute on additional “strategic and capital investment opportunities” as they arise.

Although shares of Daylight Energy have weakened recently, along with the general market downturn, we remain convinced of our investment thesis.  Daylight has an inventory of high quality assets, solid management and yields an attractive 7.0% at current price levels.  Further, both Anthony Lambert and Steve Nielsen have been buying stock on the open market in July, at prices between $8.58 and $8.95 per share.  In short, we continue to believe that the Company will soon be one of the premiere mid-tier exploration and production companies in Canada.