BTE - Baytex Energy: What Happens Next

2024-01-20 08:04:23 ET

Summary

• Baytex Energy has completed a major acquisition and must now justify it to shareholders through earnings and operational improvements.
• The acquisition of Eagle Ford properties has lowered the company's corporate breakeven due to lower operating costs.
• Management will compare the results of acquired Eagle Ford wells with those operated by Marathon and aim to decrease well costs while maintaining and probably increasing production levels.
• The additional light oil cash flow makes the expansion of Clearwater's heavy oil production far safer.
• Earnings will likely grow faster than production in the next few years.

Baytex Energy ( BTE ) made a major acquisition which is now completed. But really, for management, the work has just begun. That acquisition needs to be justified in the eyes of shareholders, either by earnings or by superior operational measures. Management's task is made harder by the fact that oil prices have kind of weakened a little since the merger completed. Touting operational improvements is not nearly as easy for management to do as showing better earnings, even if those earnings come from higher commodity prices and operational improvements. But management has already begun the messaging. That alone could help the stock price achieve better valuation.

The acquisition of Eagle Ford properties that were owned by Ranger Oil ( ROCC ) lowered the corporate breakeven because the Eagle Ford has lower operating costs. It should be noted that management regularly provides a breakdown between Canadian and United States operations in the Sedar filings, which helps investors determine progress made. All reporting is in Canadian Dollars unless otherwise noted. Therefore, investors need to keep in mind the exchange rate at the time of the report (which is also in the Sedar reports).

Breakeven Comparison

The first thing management will likely do is compare overall results as shown below with the operated Eagle Ford (which was the Ranger Oil leases) and the Karnes Trough Eagle Ford (operated by Marathon).

Note that this January Presentation is actually one month better than the November Presentation for the Marathon operated (Karnes Trough) Eagle Ford leases. This is in spite of the fact that oil prices have been at least perceived to have a weaker price outlook than is the case in November.

The larger consideration is that the acquired Eagle Ford wells have a lower return than the Marathon operated wells, despite having a higher percentage of oil. This is shown by the extra months needed to payback. Therefore, the first order of business is likely to be a review of those well costs to see if there is a way to bring the well costs down while maintaining production levels.

In fact, it is very likely that management will attempt to keep up with improving production reports throughout the industry while decreasing well costs. Marathon Oil ( MRO ) is one of the better operators in the business. Baytex, as a partner, has access to the operating information on that acreage. Therefore, Baytex should be able to use some of the Marathon experience gained in the partnership to improve the operating results for the operated properties.

More importantly, if the improvement can be attained, it indicates an immediate cash flow benefit that really was not mentioned to shareholders during the acquisition process.

Clearwater Effect

The additional light oil production means that more heavy oil production can be pursued without endangering the company finances in any cyclical downturn.

One of the dangers of heavy oil is that the discount for heavy oil prices can expand to the point that the 500% return shown above can disappear in a downturn. That would mean no or negative cash flow in a cyclical downturn so that production would have to be shut-in until a pricing recovery occurs.

Now the company is in a position to take further advantage of that great return without worrying about cash flow during a cyclical downturn.

The other heavy oil prospects (and even the Eagle Ford) shown above do not have anything close to the profit potential in the current environment as Clearwater. Therefore, activity there is probably limited to hanging onto the acreage at the current time. Clearwater will clearly out-compete the other heavy oil acreage for capital dollars.

The reason for holding the acreage is that technology keeps advancing. It could possibly advance in such a way as to bring more acreage into competition with Clearwater in the future.

Overall, now there is enough light oil production that the debt can be serviced in a cyclical downturn. That is easily the main concern. Otherwise, the company would have to put some money aside for a downturn to enable survival if cash flow became too low or vanished completely.

Duvernay

The Duvernay leases are in a similar position to the acquired Eagle Ford acreage (with the Ranger Oil acquisition). That is the costs need to come down before that acreage is competitive with the light oil production elsewhere.

Management has noted several times that they are applying what was learned from the Eagle Ford production to the Duvernay in an attempt to lower the breakeven point.

Until there is an acceptable model, management usually plans several wells each year and then takes the information gained back to study while planning "new and improved" wells the following year. It is not unusual for some of these discoveries to take years before they can be mass-produced.

Finances

Despite the increase in debt, finances are in better shape than they have been in years.

Given the commitment to bring the debt balance down to essentially the bonds outstanding, the company is very unlikely to float more bonds to repay the debt shown above. Most likely, management will simply pay down the bank line.

Most banks do not like the bank line to be outstanding when other debt is repaid, and oftentimes put terms in the credit line contract to that effect. Even if they do not, banking relations may suffer if someone would happen to not repay the bank line first.

But the important thing is that in the current environment, the Eagle Ford production can likely handle the debt servicing requirements. That means that United States dollar earnings can pay United States dollar debt, no matter what the currency gains and losses are for accounting purposes.

The other consideration is that the debt ratio is fine in the current market environment. But the debt goal represents a satisfactory debt ratio using far more conservative commodity price assumptions, as noted in the slide above.

This tends to confirm there is a debt market push for an immediate debt ratio of 1.0 to maybe 1.3 (give or take) while moving towards something more conservative "just in case".

Conclusion

Baytex Energy has some very profitable as in margin improving growth ahead of it. Therefore, earnings are likely to grow faster than revenue for the next few years. That could be a long-term possibility thanks to the profitability of Clearwater.

The constraint is that the company cannot grow using debt because the heavy oil production really does not permit a debt scenario. The heavy oil production is likely to produce insufficient or even negative cash flow during a time of weak commodity prices. Now, the Clearwater play has unusually low breakeven points for a discounted product. However, no one is counting on that producing sufficient cash flow at the current time.

Baytex Energy remains a strong buy based upon production improvements in the Eagle Ford and successful expansion of the Clearwater production in the future.

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