APA - Paramount Resources: Debt Free And Rapidly Growing

2023-06-19 06:21:53 ET

Summary

• The wildfires are seen as a one-time event that is not usually this significant.
• The growth story remains intact.
• The company has no long-term debt.
• This is one of the few companies providing a generous dividend and growing production.
• The transition from an asset story to a cash flow machine is finished.

(Note: This is a Canadian company that reports using Canadian dollars.)

Paramount Resources ( PRMRF ) is one of the harder hit companies from the Alberta wildfires. But even a severe year like the current wildfire year is generally not more than a one quarter issue. In fact, it is rarely even close to that. So, it is probably best for shareholders to concentrate on achievements like debt free and long-term rapid growth rather than the events of the second quarter. This is a company that began really as an asset play and grew by selling the assets from time to time while reinvesting the proceeds. Now this management has created a cash flow monster poised for a lot of growth and dividends ahead.

The story began when the company acquired Apache Canada from Apache ( APA ) several years ago. Paramount acquired the subsidiary from Apache in 2017 for C$460 million. Ever since then, the company has been optimizing this giant project (for the size of the company) into something far more profitable. Needless to say, the acquisition, or what is left of it, is worth far more today than it was back when it was purchased.

This is one of very few companies that has paid all its debt off and therefore is not in debt at all. The cash flow for the size of the company is tremendous and can therefore be used for both growth and dividend payments to shareholders. As a result, the dividend has been increased several times since it was initiated. Even with the conversion to United States dollars, the monthly dividend of C$.125 represents a darn good return on the current price of the stock.

The emphasis on condensate production shown above leads to above-average profitability. Condensate is often sold for a premium to WTI pricing in Canada because Canada often imports condensate to meet its needs. That premium allows for above-average profitability when the production is as significant as the amount shown.

Now the wildfires will unexpectedly influence second quarter production. Those wildfires may have also delayed some capital expenditures as well. Even with those issues, the growth story is clearly intact. Management could make up for lost production time easily in the coming quarters if they chose to do so.

The company has no long-term debt. So, if borrowing becomes necessary to maintain the guided growth pace, then that is certainly an option.

The key idea is that the wildfires do not cost management the ability to pursue the growth as shown in the bottom part of the slide. The wildfires have only affected current production. Those same wildfires may delay some development drilling as well. But delays are not the same as permanent impairment (that will not happen).

There will likely be an update to the average annual 2023 production as soon as the situation caused by the wildfires is quantified. At one point, management had about 38K BOED shut in. That is definitely significant enough to make the second quarter a disappointment. Usually, the wildfires do not cause an impact of that significance.

Production

As the slide above shows, the company has shifted from a dry gas producer (now it is years ago or early in the corporate life) to basically a rich gas producer. The result is some very low-cost production. Management has the company well-placed as North America increases the ability to export natural gas. It is quite possible this company has two premium products to sell in the future (natural gas and condensate).

This is a management that often gets an area to an optimal marketing situation. Management then sells the area opportunistically and then reinvests the proceeds in an undeveloped area to begin the process again.

The difference now is that the company is large enough to retain significant production so that cash flow does not likewise start over again.

Management has been very successful in selling projects in the past. There is a similar history of taking positions in both private and public companies. Management then later either sells the position or merges with the investment to develop it further.

The most likely time for the company to sell leases is when they reach the Harvest part of the lifecycle. This company does not keep areas that do not grow for the most part.

In the past, this strategy resulted in some stretched ratios that were downright scary until the sale occurred. Now there is sufficient cash flow to prevent that. So, management can maintain a conservative financial position by most accounts while acquiring, buying and selling as it has in the past.

Financial analysis can be complicated as there is a mutual fund aspect to the various holdings as well as the significance of the periodic sales that make a growth story hard to follow. But what appears to be happening now is growth in spite of a significant disposition that happened recently. That would make the story for the market far easier to understand.

Summary

Paramount Resources has evolved from an asset story where periodic sales were critical to the continuing development of the assets to a point where operations are now large enough to continue to grow.

The assets developed have very low costs. Therefore, this company has through both sales and cash flow repaid all of its long-term debt. Management is now well ahead of much of the industry that needs to repair their balance sheets. Here, a combination of growth and dividends is enabled by the lack of long-term debt.

Management can borrow to keep the growth pace on track if management chooses to do so after something like wildfires. But the overall investment risk of an upstream company with no debt is generally considered below average.

Furthermore, much of the industry is out of favor. So, the C$.125 monthly dividend per share provides a generous return even to United States investors. That dividend is likely to continue to grow rapidly as more profitable leases are developed.

This issue can be considered a strong buy based upon the debt free balance sheet and the extremely low cost (and hence very profitable) production. This is a family-owned business with insiders owning nearly half of the outstanding shares. These types of businesses often outperform their industry.

Furthermore, many family-owned businesses at some point are sold for darn good prices when key people want to retire and there is no one in the next generation that can run the operation. Even if the company is not sold, it has an above-average future based upon the sale of condensate and the positive outlook for exporting natural gas. At the current price, the downside risk is minimal with the generous dividend. The upside is still considerable.

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