CA - Pine Cliff Energy: A Dividend-Paying Call Option On The Natural Gas Price

2023-10-12 11:30:00 ET

Summary

• Pine Cliff Energy is seen as a call option on natural gas prices due to its limited reserve life and low capex requirements.
• Q2 results show majority of production is natural gas, with low prices impacting revenue.
• The company's cash flow statement is more important than its income statement, as it is generating strong cash flows despite being loss-making.

Introduction

As I explained in a previous article, I don't see a whole lot of fundamental value in Pine Cliff Energy ( PIFYF ) ( PNE:CA ) as the reserve life is pretty limited and in my personal situation as an offshore investor, receiving the incoming free cash flow as dividends is not the most optimal solution. That being said, I do think Pine Cliff still is an excellent call option on the natural gas price, as the share price should react well to price spikes in the next few years.

A look at the Q2 results

Pine Cliff produced an average of just over 20,000 boe/day in the second quarter of this year and the vast majority of this production was related to natural gas as the NGL production was just 1,343 barrels per day while the crude oil production represented just 1,184 barrels per day. And while the oil and NGLs were sold at reasonable prices, Pine Cliff obviously also had to suffer through a quarter with relatively low natural gas prices as its net realized price was C$2.79 per Mcf, which is less than half its sales price in the second quarter of last year and about 20% lower than the realized price in the first quarter of the year.

The company generated a total revenue of C$42.3M from the sale of its oil and gas products, while the total reported revenue was C$39.7M. This includes the royalty payments but also includes the interest income and processing and gathering revenue. And as you can see below, the pure operating and transportation expenses were relatively low at almost C$26M. While that definitely means the company was generating a positive cash flow on the operating level, let's also not forget those operating expenses are the equivalent of C$2.35 per Mcf produced, and it really is thanks to the oil and NGL revenue that the company's financial performance remained decent. Although only 12.5% of the production rate came from liquids, the stronger prices for liquids did result in a substantial increase in the revenue per Mcf-equivalent which increased to C$3.83.

The company was not profitable in the second quarter of the year, and that's mainly due to the high depreciation and depletion expenses. As the useful life of Pine Cliff's main operations is coming to an end, the company does not have to spend a lot of cash on capital expenditures anymore. The company is guiding for a full-year capex of C$27.9M, which represents just C$7M per quarter and that's more than 30% lower than the depreciation expenses.

And that's why the cash flow statement is more important in Pine Cliff's case than the income statement. Although the company is loss-making, it is still generating strong cash flows. As you can see below, the total reported operating cash flow was C$12.5M, which includes a C$0.8M cash outflow related to the decommissioning and includes about C$1.3M in working capital releases. Adjusted for these working capital changes and the C$0.27M in lease payments, the underlying operating cash flow was approximately C$10.95M.

The total capex was C$8.2M during the second quarter, which already is lower than the depreciation expenses, but it still is higher than the average of C$7M per quarter. The adjusted free cash flow in Q2 was approximately C$2.76M, or C$0.0077 per share. Using the normalized capex, the underlying free cash flow was C$0.011 per share during Q2. And this further strengthens my thesis that Pine Cliff is not necessarily a 'buy and hold' stock nor an income idea, as the dividends were not fully covered by free cash flow in the second quarter of the year. The underlying (and normalized) free cash flow result for the first semester was just over C$0.04 per share.

While the company calls its dividend 'sustainable', it admits it is only sustainable if you include the existing (strong) net cash position of C$55M, which is currently being drained to keep the dividend fully covered.

I think that's a pretty flexible interpretation of what constitutes a sustainable dividend, but it does confirm the company's commitment to continue to pay the monthly dividends. But the longer the natural gas price remains weak, the more the cash position will be drained.

The updated guidance

Based on the pretty weak performance in Q1 and Q2, it didn't really come as a surprise to see Pine Cliff tweaking its plans. The company is deferring the drilling of its final well to 2024 and will instead spend more time and money on the recompletion work in another area of its activities. Pine Cliff thinks the deferral of the capex into 2024 will result in a lower overall cost basis for the 2024 drill program, as it anticipates it can benefit from economies of scale. The total capex will remain unchanged at around C$28M, but Pine Cliff will spend the money in a different way.

And thanks to the low decline rate it should not see any negative impact from drilling fewer wells and the production rate will likely remain stable at just over 20,000 boe/day (July already was a pretty strong month).

Investment thesis

I consider Pine Cliff to be a trading vehicle to gain exposure to and surf on the momentum of natural gas prices. While investors could look at the company as a ' cigar butt' strategy where all cash flows from the remaining limited useful life are distributed to the shareholders, that strategy does not work for me personally. I think it is better to look at Pine Cliff as a call option on the natural gas price, thanks to its low capex requirements and robust net cash position.

I currently have no position in Pine Cliff, but I have been trading in and out of the stock and I plan to re-enter on a weak trading day.

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