The Canadian oil & gas space has been a disaster zone for investors over the past few years. The first crisis to hit was the global oil price crash that kicked off in late-2014. The industry was then rocked again at the end of last year in a localized price crash caused by a supply glut; itself due to a shortage of export capacity. That second crash saw the oil price differential – that is the difference between Canadian and American oil pricing – reach as high as $50 per barrel.
Bonterra Energy (TSX: BNE), like nearly all Canadian oil producers, hasn’t escaped the carnage. As a smaller producer pumping out around 13,000 barrels of oil equivalent (BOE) per day in Alberta you wouldn’t really expect it to either. Before the first oil price crash its stock traded as high as CAD $65 on the Toronto Stock Exchange. Right now it trades around the CAD $5.85 mark. The dividend has followed a similar trajectory. Back in 2014 Bonterra stock pumped out over CAD $3.50 per share over the course of the year. This year it will likely pay out just CAD $0.12 per share.
Ultimately there are three things that currently define Bonterra. Firstly, it is a profitable and low cost producer. Its primary asset in the Pembina Cardium is conventional, no frills and well understood. It currently costs the company around CAD $14.85 to lift one BOE from the ground (US $11). Throw in other business costs – e.g. royalties, interest on debt, salaries for employees and so on – and you get an “all in” cash cost of around CAD $23 per BOE (US $17).
Now, In the first quarter of of 2019 Bonterra’s realized revenue per BOE was just over CAD $46. In other words it is throwing off “cash flow” of around CAD $21 per barrel at Q1 2019 prices. On 13,000 BOE per day of production we can therefore expect annual cash flow of around CAD $100 million. (This of course assumes that Q1 prices are representative of 2019 as a whole). From this cash flow Bonterra has to then spend around CAD $60 million per year drilling new wells to keep production levels flat. Actual “free” cash flow is therefore currently around CAD $40 million (CAD $1.20 per share) on an annual basis.
This brings us to point number two: the debt level. In an ideal world Bonterra could share most, if not all, of that free cash flow with stockholders. Indeed this has been the case for much of the company’s history. For example since the late 1990s it has paid out over CAD $40 per share in total cash dividends. The bad news is that the company currently sits on total net debt of around CAD $330 million. Leaving aside approximately CAD $4 million (which is the current dividend spend per year), management have sensibly decided that all surplus cash generation should go towards reducing that debt load.
The good news (and the third and final point) is that the valuation is absurdly cheap. Indeed the stock price is so depressed that Bonterra could essential wind down, cease drilling new wells, let the oil production decline year by year and still payout more than its current share price after paying off all of its debt. The market doesn’t care for two reasons. Firstly, the token dividend level equates to a yield of just 2%. Nobody is buying this for the current dividend. Secondly, the Canadian oil patch is still under threat from another blowout in oil differentials until it builds out more export capacity.
Ultimately we are still left in deep deep value territory. At some point net debt will return to a more sensible level, probably mid-2020 all things being equal. Management could then be free to increase the dividend by an order of magnitude or more.
Of course the ‘could‘ in that statement is entirely dependent on Canadian oil prices. As mentioned above the largest risk is that of another localized price depression. Being a conservative kind of investor I like to look at the worst case scenario, which in this case looks a little like Q4 of last year. In Q4 2018 Bonterra only realized oil revenue per barrel of CAD $38.96 (US $28.90). Overall revenue per BOE (i.e. taking into account natural gas and NGL production) clocked in at CAD $29.74 (US $21.30). Even in that extreme pricing scenario Bonterra generated positive cash flow of CAD $8 per BOE. At that point it could theoretically lower CapEx to a minimum without risking the further degradation of its balance sheet. It is also worth pointing out that such an extreme low price would probably not persist for more than a few months.
As it stands Edmonton Mixed Sweet crude oil trades at around CAD $66.50 (US $50). (Of its 13,000 BOE production over 60% is oil and Bonterra receives a slightly discounted price to Edmonton Mixed Sweet benchmark pricing). At that pricing the company throws off roughly CAD $40 million in annual free cash flow; enough to materially reduce its debt load in the short term. Now to me $50 oil doesn’t seem very high. If we use it as a long-term average then at some point soon Bonterra will be free to divert most of its free cash flow to dividend payments rather than debt reduction. Anyone willing to pay CAD $5.85 per share to buy stock today could be looking at a dividend yield on cost of 20% within a year to eighteen months.