Bombed out energy companies are not hard to find in Canada at the moment. As I mentioned in the previous piece covering one such name, Bonterra Energy, the oil & gas industry there has been through the wringer as a result of the late-2018 collapse in local oil prices. Equity prices have not yet recovered despite the Canadian Crude Index making significant gains from its catastrophic lows.
A second company that has been buried deep in the value bin as a result of the carnage is Cardinal Energy (TSX: CJ). Like Bonterra it is a pretty small company, with total production currently at around 20,000 barrels of oil equivalent (BOE) per day. Unlike Bonterra, Cardinal pumps a mixture of different oil types as well as natural gas and natural gas liquids (NGLs). Of its 20,000 BOE per day production, around 8,500 barrels per day represents heavier oil. Cardinal’s realized prices here are pretty much identical to Western Canadian Select benchmark prices. Another 8,250 barrels per day is lighter oil, of which Cardinal realizes prices at a discount to Edmonton Mixed Sweet benchmark prices. NGLs account for around 950 barrels per day, with natural gas making up the remaining 2,500 BOE.
Now let’s get to the finances which is where Cardinal has a few things going for it. Firstly, it is a fairly low cost producer. Over the first three months of 2019 its “all-in” cash cost per BOE came to around CAD $35 (US $26.25). Total realized revenue for the period clocked in at CAD $51 (US $38.25) per BOE. At Q1 Canadian oil prices that puts Cardinal’s total annual cash generation at around CAD $110 million.
Secondly, its decline rate is quite low at around 10%. In other words if Cardinal stopped drilling new wells then in one year its production would drop from 20,000 barrels per day to 18,000 per day. Across the Canadian oil & gas space that is a very good figure. One of the upshots to this is that the company doesn’t need to that spend much, relatively speaking, to maintain production levels. This year’s CapEx budget of around CAD $50 million will keep things flat at the 20,000 BOE per day mark. All-in-all we are therefore looking at a reasonable free cash flow estimate of approximately CAD $50-$60 million in 2019 assuming stable oil prices.
The third point I’d make regarding finances concerns the debt level. Cardinal is less leveraged than Bonterra – with total net debt of CAD $260 million equivalent to 2.5x cash flow. (Bonterra’s net debt to cash flow ratio stands at around 3.5). As a consequence the company is currently able to support a higher level of dividend payments. From July Cardinal will pay out CAD ¢1.5 per month to shareholders. Over the course of one year that equates to around CAD $22 million based on the 120 million Cardinal shares currently in existence. In other words Cardinal’s dividend is sustainable in the current pricing environment. We are actually left with a CAD $28 million surplus based on the free cash flow figure quoted above. As you’ve probably already guessed the focus of that surplus right now is on debt reduction.
The rest of the story goes pretty much like Bonterra’s. As net debt gradually reduces Cardinal will be able to allocate increasingly more of that surplus cash towards dividend distributions. The upside is quite substantial. For instance a dividend raise of CAD ¢0.5 per month per share would only cost Cardinal CAD $7.5 million per year. It would, however, take the forward dividend yield from 7% to over 9.5%. If the market responded proportionately the share price would also jump by 30%. In theory Cardinal could manage this at current oil prices; management though is prioritizing debt reduction until next year. Given Cardinal currently pays around CAD $10 million per year in annual interest there is enough scope to self fund a dividend raise through the delveraging process. Assuming oil prices don’t collapse further expect another dividend raise to happen in the first half of 2020.
That’s the income case. The short version: get nearly 7% now, easily sustainable at current oil prices, with a double digit yield on cost next year (assuming oil prices don’t crater). Lastly, let’s just take a look at the value situation on an absolute basis. Cardinal’s book value is over CAD $6 per share right now. The company could theoretically liquidate, pay off all its debts and other liabilities, and send that figure to shareholders. You can ‘buy’ that $6 per share book value for $2.60 per share right now on the Toronto Stock Exchange. Commodity stocks are cyclical beasts, and right now sentiment in the Canadian oil and gas industry is catastrophically low. At some point price to book values will revert back towards normality. When they do Cardinal and Bonterra will have an excellent chance of generating stellar returns for those buying at these depressed prices.