GENGF - Gear Energy: Printing Cash With No End In Sight

• Gear Energy has taken advantage of the strong oil and gas prices to convert a net debt position into a net cash position.
• Although the H2 capex will come in much higher than in H1, the strong oil and gas prices will help to protect the balance sheet.
• Gear is now paying a monthly dividend of C$0.01 which is well-covered, giving the shareholders a well-deserved payout.

Introduction

Gear Energy ( OTCQX:GENGF ) has done an excellent job cleaning up its balance sheet , helped by the very strong oil and gas price. The second quarter was excellent and the company ended the quarter with a net cash position of almost C$10M.

A strong oil price with a decent production rhythm equals massive cash flows

Gear Energy produced on average almost 5,800 boe/day during the second quarter of which about 80% consisted of oil (further broken down in 60% heavy oil and approximately 40% light and medium oil). Thanks to the very high average prices (C$117/barrel for heavy oil and C$133/barrel for light and medium oil while the average natural gas price for the quarter was approximately C$7.38 per mcf.

All the ingredients were present for an excellent quarter and Gear did not disappoint. The total revenue increased to almost C$58M and after taking the royalty payments and hedging losses into account, the net revenue came in at C$48.4M The operating costs remained very reasonable and the total expenses came in at C$25M, virtually unchanged compared to the first quarter.

And the combination of a much higher revenue and an unchanged expense basis caused the pre-tax (and net) income to quadruple and the Q2 EPS came in at C$0.09. Not bad for a stock trading at C$1.20.

Looking at the cash flow statements, the company reported an operating cash flow of C$30M and an adjusted operating cash flow of C$33M (which includes about C$1.1M in cash paid to settle decommissioning liabilities.

The total capex was just around C$8.1M which results in an attributable free cash flow of C$25M and given the current share count of 258.2M shares, the free cash flow per share was almost C$0.10. Combine this with the net cash position, and Gear Energy is currently trading at a 40% free cash flow yield versus the enterprise value. However, we can’t just annualize the H1 results as Gear plans to ramp up its capex spending in the second semester.

Now the cash has been pouring in, Gear Energy has initiated a dividend policy and although the previous one had just been put in place, the company is now already updating it to a monthly payment of C$0.01 per share to increase the visibility. At the current share price, this means Gear’s stock will be yielding approximately 10% with plenty of cash being retained on the balance sheet.

Keep in mind the free cash flow in the second half of this year will be lower as the company has updated its full-year capex to C$64M (up from C$55M). Despite the higher capex, the full-year production guidance has been scaled back from 5,900-6000 boe/day to ‘just’ 5,700-5,900 boe/day but this is just related to a timing issue.

Some of the new wells will be drilled in the second half of the year and this should increase the output by 10% in the first quarter of 2023, as Gear Energy is guiding for a production rate of 6,400 barrels of oil-equivalent per day.

This also means we shouldn’t expect Gear to end this year with a higher net cash position than the current net cash position as the incoming operating cash flow will likely entirely be spent on the capex and the dividends. And then it will be interesting to see what Gear is planning on doing in 2023 and its planned growth rate and capex spending will likely be determined by the oil price towards the end of this year.

Investment thesis

Gear Energy has cleaned up its balance sheet and will likely continue to have a net cash position. This doesn’t mean the company will stop investing as the high oil and gas prices will provide plenty of cash flow to slowly increase its production without having to take on any additional debt while continuing the generous dividend policy.

I currently have no position in Gear Energy but I admire how the company’s management team has gotten the company through the difficult times in 2020 and has done the right thing to protect shareholder value. Additionally, the monthly updates are an excellent way to keep the shareholders up to date on the progress made on a month-to-month basis rather than keeping everyone in the dark until the quarterly results come out.

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