MUR - Athabasca Oil: Get Those Costs Down While Resetting Balance Sheet

Summary

• Repayment of all debt should be the first priority.
• Costs are too high to allow for debt on the balance sheet long term.
• Management is comfortable with a large balance as it tends to "shop" during downturns to find bargains that benefit shareholders.
• Cenovus demonstrates far lower costs than Athabasca and can refine production to higher valued added sales products.
• Overall, management has made good progress. But there is a lot of work still to be done.

(Note: This article was in the newsletter on March 1, 2023.)

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

Athabasca Oil ( OTCPK:ATHOF ) has a "once in a lifetime chance" to reset the balance sheet. Most of these companies had lots of debt thanks to the struggle of the period from 2015 to 2020. The robust commodity prices have allowed margins and cash flow not seen in ages which has many CEO's talking about the chance of a lifetime to reset balance sheets. Many feel we may not see another chance like this for a generation or so.

Therefore, the idea that "net debt" solves the problem is probably not the case because this organization has a history of doing deals. Therefore, the debt should probably be repaid completely while the management builds a large cash position to go shopping during the next downturn.

But that is not the only thing that needs to happen. The company inherited some high costs when they purchased the thermal production to add to what production they already had. Much of that production was relatively high cost also. So naturally a conservative balance sheet will buffer some of the effects of any cyclical downturn. But a priority remains to get those production costs down "across the board". To some extent, management is working on this. But there is a need to raise the priority of cost reduction while the good times are around. That also will help the company performance during the next industry downturn. So, there is a lot of work for management to do.

Finances First

Management announced a nominal amount of net debt. But that net debt is made up of Canadian dollars and United States denominated debt. Management has always seen a need to keep a lot of cash on hand. What they should do is build up a large net cash position and pay off the debt entirely.

The company has the yearend structure shown above. That represents serious financial progress for what was a debt heavy firm. The issue is that the firm is talking about taking free cash flow (as defined by management) and returning that cash flow to shareholders.

But this management has a history of "doing deals". Rather than maintain the debt balance, management should pay it off and build up the cash balance because this management is very likely to go shopping during the next cyclical downturn. In so doing, management is likely to make a far better return for shareholders than returning the cash. In that context, maintaining a large cash balance at the cost of the debt seems to make little sense.

Right now, management appears bent on share repurchases and maybe a dividend while maintaining the debt balance to some extent. In the long run, such a strategy will cost money to the debt of the debt interest (and it can be easily avoided). Based upon the forecast free cash flow, management can easily repay debt and build the cash balance in the process to a suitable level.

Costs Next

Cost progress has been made for some time. But more progress needs to be made. It is generally hard for a thermal or heavy oil producer to survive in the current environment when product discounts widen in a downturn unless costs are "rock bottom".

This is a summary of the annual costs of one of the thermal oil operations. One can easily see that the costs including royalties are running in the C$35 (using the annual numbers) per barrel range. Actually, this is a very good year for the costs (Royalties, Operating Expenses, and Marketing). The history in the financial statements showed higher costs in the past. After operating costs, there is still administration and interest (for example). Costs are way out of line here for an entity that wants to survive long term. Even without the royalty costs that is still much too high.

For a quick comparison of some key costs here is the Cenovus ( CVE ) guidance:

(Canadian Dollars Unless Otherwise Noted)

Note how much lower the presented Cenovus costs are. The best Cenovus properties are running at a considerably lower production cost than is the case with Athabasca. Unfortunately, this is usually the case in the industry because larger companies can often get the best properties. Investors are free to compare the two companies for more comparisons. But this gives some idea as to how much progress management needs to make.

Cenovus also has the additional advantage of refining to add value to the thermal product produced (and therefore avoid the discount to WTI pricing entirely). It might be a good idea for Athabasca management to consider some refining or upgrading capabilities in the future to avoid the worst effects of a cyclical downturn.

Light Oil Costs

Light oil costs are also on the high side.

All one has to do is look at the well costs. Even in Canadian dollars those well costs are on the high side. Murphy Oil ( MUR ) the joint venture partner in this light oil project, notes in almost every conference call that they are working on costs. Once that happens, then it is very likely that Murphy will propose to rapidly develop the leases. That would require some cash on the part of Athabasca. It would also be a good reason for Athabasca to repay the debt to keep the financial leverage low on a premium oil project like this one.

Likewise, Baytex Energy ( BTE ) has a Pembina Duvernay discovery that they are also working to get the cost down. The whole idea for everyone in this type of project is to get the breakeven to a "rock bottom" number before committing large amounts of capital to develop the projects.

The Future

Athabasca Oil has made a lot of financial and cost progress since they purchased the thermal production and then brought online more thermal production. The joint venture for light oil appears to be a needed cash flow item during cyclical downturns when the pricing discount for thermal and heavy oil often widens.

But there is so much more work to be done that a very conservative financial stance appears to be prudent. Therefore, free cash flow should first repay any debt while maintaining that hefty cash balance that management is comfortable with. This management tends to do deals and those deals tend to benefit shareholders over the long term.

Anytime a company is not the low-cost leader, then debt should not be part of the balance sheet in case the next cyclical downturn is unexpectedly severe. Low-cost leaders survive most downturns. But this company is not a low-cost leader. That means that management proposals to give back to shareholders may prove to be long-term foolhardy at this point.

This management survived the last downturn with all that debt. It is probably wise not to try "two-in-a-row". That is getting too close to "rolling the dice". There will clearly be a time and a place to return money to shareholders. But right now, appears to be too soon.

For further details see: