CA - Advantage Energy: Let The Good Times Roll

Summary

• A strong balance sheet is a priority.
• Growing production is a priority.
• The company is unlikely to pay dividends.
• Well profitabilities are among the best in the industry.
• The company is very likely to be an acquisition candidate in the future.

(Note: This is a Canadian company that reports in Canadian dollars unless otherwise indicated.)

Advantage Energy (AAVVF) has long focused on growth and of course, a strong balance sheet. The lean times really made it tough on the company. But now the company is relatively flush with cash flow. The company is retiring stock both with a repurchase program and now an offer . The latest results of that offer will reduce shares outstanding by roughly 9 million shares.

This company generally will not pay a dividend. It is very likely that there are still some synergies to be gained by the company becoming larger. But the other thing is that the wells drilled are extremely profitable. In my book, there is no reason to return money to me when the wells drilled are as profitable as the company shows. That probably puts me at odds with the prevailing market attitude. But I firmly believe that a growing company is worth a lot more because of compounding than is a company that pays a lot of dividends.

Well Profitability

This company drills wells that break even in months under a wide variety of industry conditions. That points to unusually good geology.

The wells return the money used for drilling and completion in less than one fiscal year. That kind of payback allows management to hedge production so that the wells produce a minimum acceptable profit. Then, even if energy prices move in an unexpectedly unfavorable direction, there is a minimal profit assured for the wells.

This management generally maintains a low enough debt load so that production can be shut-in if needed or production can continue while management simply "collects checks" until a recovery is underway.

The kind of returns shown above point to a very low breakeven point. This company can operate under low commodity prices when many competitors cannot. That is a very important competitive advantage.

The company is intent on keeping the cost leadership that it has in the industry by attacking both the costs as shown above and improving well performance. Most commodity industries face a constant competitive pressure to reduce costs over time. The way this is done is through continuing technology improvements. The company already has an important cost advantage. The graphs above are an attempt by management to keep that cost advantage well into the future.

The interesting thing is that North America is increasingly able to export natural gas to the far stronger world market prices. For a company like Advantage that is unrelenting in driving down costs, the company faces a future stronger price natural gas market due to the rising export ability combined with constant cost reductions as long as what is shown above continues. That makes for a commodity paradise of widening profitability in excess of production growth or what rising prices would bring. It therefore implies that this company has a good chance to outperform the industry in the future.

Liquids Diversification

One of the newer trends of production is the increasing role that liquids will play in the future.

Advantage Energy was long a dry gas producer. Any other products were simply not a large enough part of production to influence the average price received for natural gas. That is now changing.

This company assumes a relationship between natural gas and all the other products to produce the profitability in each area. But that relationship can change if one product becomes over or under supplied. That would influence the relative profitability of the operating areas.

This is why many managements, including this one will shift priorities towards one area depending upon market conditions. But they keep their presence in different locations to assure decent profitability under a wider variety of industry conditions.

The whole situation also makes both well and corporate breakeven points complicated because it depends upon a matrix of input product pricing rather than just the price of natural gas (as was the case in the past).

Entropy

Advantage Energy has founded Entropy and it has now been funded by Brookfield as shown below. There is a chance that this will go public at some point to add considerable value to the company.

Advantage Energy founded Entropy and Brookfield has essentially funded the scaling up of the venture. This is yet another carbon capture venture formed to take advantage of market sentiment. The neat part about this industry is that any carbon dioxide that is captured may eventually be used in secondary recovery to recover more product.

Right now, that is not discussed much as much of the industry either purchases or produces its own carbon dioxide from wells. But the current trend to eliminate carbon dioxide emissions is going to create a lot of supply of carbon dioxide that can be used to recover more product as all of these unconventional wells age.

Secondary recovery in the unconventional business is not a hot topic because many of the wells are still very young. But the conventional business has long used both carbon dioxide and water to recover more product once it becomes cost effective to do so.

The Future

Advantage Energy is one of the lowest cost natural gas producers that I follow. The slow movement into more liquids production has been accompanied by a desire to keep the same costs of production (where possible) as is the case with dry gas. That strategy generally shows a very low-cost increase with the move to liquids production while the excess production values that come with the liquids head straight "to the bottom line".

The result of this diversification is decent profitability under a wider variety of industry conditions. It does make the well breakeven discussion complicated because the wells produce a variety of products. Breakeven therefore depends upon the assumed pricing relation of the products. That pricing relationship is often very flexible because oversupplies and undersupplies happen all the time.

The emphasis is likely to be on corporate growth with low costs and a strong balance sheet. Companies like this often become a takeover candidate at some point in the future. This is a very profitable little company. That is just what potential buyers look for. In the meantime, a dividend of meaningful size is very unlikely for the foreseeable future.

The conservative balance sheet and unusually good profitability may appeal to a wide variety of investors.

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