CA - ARC Resources: One Of The Better Companies To Gain Exposure To Natural Gas

2023-10-09 10:30:00 ET

Summary

• ARC Resources is one of the largest natural gas producers in North America, with natural gas sales representing just 30% of total revenue.
• The company remained profitable despite low natural gas prices, posting a net income of C$279M.
• ARC Resources plans to increase production rate to well over 400,000 boe/day by 2028, with a projected operating cash flow of C$3.5B.

Introduction

It’s been more than a year since I called ARC Resources ( ARX:CA ) ( AETUF ) the ‘ king of natural gas’ . Since that article was published, the natural gas price has obviously decreased and this provides an interesting look under the hood to see how ARC is performing in a low-price environment.

Waiting for the natural gas price to increase

ARC Resources is one of the largest natural gas producers in North America as about 63% of its production rate of 343,000 barrels of oil equivalent per day effectively consists of natural gas. The company also produces approximately 8,100 barrels of oil, 75,500 barrels of condensate, and about 45,200 barrels of NGL on an average day.

The company received an average price of almost C$88 for its oil and in excess of C$93 per barrel of condensate. The natural gas was sold at an average of C$2.83 per Mcf.

Due to the low natural gas price, the natural gas sales represented just 30% of the total revenue of C$1.12B generated during the second quarter. As you can see below, the oil and condensate sales accounted for in excess of 60% of the total revenue.

The total reported revenue was C$1.21B and as you can see below, the difference with the C$1.12B above is mainly caused by the revenue from the sale of commodities purchased from third parties. That’s a low-margin business (ARC recorded a margin of just C$4.5M on those sales), offset by the C$137M in royalty payments.

The total reported revenue including the C$119M hedging gain was C$1.33B. The total amount of operating expenses was just C$971M and this resulted in a pre-tax income of C$358M. As you can see in the income statement above, the operating and transportation expenses are relatively low and the depletion and deprecation expenses are actually a more important cost factor.

Despite the low realized natural gas price, the company remained profitable and ARC Resources posted a net income of C$279M or C$0.46 per share. That’s great but keep in mind this includes approximately C$119M in hedging gains.

That’s why I think the cash flow statement offers a more interesting perspective. As you can see below, about C$128M of the hedging gains were unrealized which actually means the company reported a small hedging loss in the second quarter of the year. The total operating cash flow was C$551M and after deducting the C$14M in lease payments and adding back the C$24M in working capital changes, the adjusted operating cash flow was C$561M.

The total capex was C$416M which means the company’s underlying free cash flow result was approximately C$145M or C$0.22 per share.

While that’s not great, keep an eye on the total capex. The combination of capex + lease payments was C$430M while the total depreciation and amortization expenses for the quarter were just C$348M. This means ARC was definitely ‘overspending’ on capital expenditures.

And that isn’t a surprise, as ARC is pushing towards production growth. As mentioned earlier in this article, the average production rate was just over 343,000 boe/day in the second quarter and the average production rate was 341,000 boe/day in the entire first semester.

But as you can see below, the company is still guiding for a full-year production rate of 350,000-355,000 boe/day. And to meet the lower end of that guidance, the average production rate in the second half of the year will already have to be close to 360,000 boe/day. To meet the mid-point of the guidance, the H2 production rate should get closer to 365,000 boe/day. And that’s a direct result of the pretty heavy capital expenditures.

ARC Resources plans to spend C$1.8-1.9B in capex this year and this should indeed boost the exit rate to roughly 365-370,000 boe/day. And it is very encouraging to see the operating cash flow should be more than sufficient to cover the full-year capex.

The Q3 results should be pretty good as well. The natural gas price was still pretty weak but I do expect to see a bump in the total revenue and the total operating cash flow thanks to the continuous increase of the oil price throughout the third quarter.

The relatively high capex is also part of a five-year growth plan. As you can see below, ARC Resources plans to increase its production rate to well in excess of 400,000 boe/day by the end of 2028 and this should result in a total free funds flow per share of close to C$5 based on US$70 WTI and a C$3.50 natural gas price.

That results in the following projection for 2028. At $70 WTI and C$3.50 AECO, the company will generate about C$3.5B in operating cash flow while it will need about C$1.9B to cover the capital expenditures and the base dividend (currently C$0.17 per share on a quarterly basis). Important; ARC Resources has put forward a dividend based on 15% of the funds from operations, so the total cost of the dividend will fluctuate with the financial performance of the company.

One of the more attractive elements of ARC’s natural gas production is its exposure to the different main markets in North America. While its guidance is based on the AECO natural gas price, the company does sell its natural gas in several different markets, at different prices. And as the natural gas price in the USA is on the rise, the company’s average realized natural gas price should benefit.

Investment thesis

ARC’s share price has performed well this year despite the weak natural gas price in North America. Investors were (and are) obviously positioning for the anticipated strong production growth and seeing the natural gas prices gain momentum actually bodes well for the company’s financial results in the second half of the year, especially considering the production rate will be more than 5% higher compared to the first half of the year.

I currently have no position in ARC Resources but despite its high share price, I’m keeping the company on my shortlist of names to gain exposure to the North American natural gas market.

For further details see: