CA - Tourmaline: Another Year Of Special Dividends

2023-04-03 11:31:01 ET

Summary

• With free cash flow guidance of $2.6B, Tourmaline intends to return 50-90% of free cash flow to shareholders in 2023.
• Investors can anticipate a steadily growing base dividend and special dividends throughout 2023.
• Tourmaline’s production growth is aligned with major egress infrastructure and is leveraged to the development of LNG export capacity in BC.
• Tourmaline is a low cost producer with its own midstream infrastructure.
• The current share price offers an attractive opportunity to buy on softer natural gas prices.

Author's Note: All figures in Canadian currency unless otherwise noted.

Investment Thesis

Since I last recommended Tourmaline Oil Corp. ( TOU:CA ) in December 2021, shares are up 47% and the company has returned $10.33/share in dividends. This company continues to demonstrate its commitment to returning capital to shareholders through a growing base dividend, quarterly special dividends and an approved share repurchase plan. With 30% of production hedged, Tourmaline anticipates free cash flow of $2.6B in 2023 with a commitment to return 50-90% to shareholders in 2023.

The development of egress infrastructure including LNG export terminals and the Costal Gas Link pipeline project will better connect Tourmaline’s Montney assets to the global market and allow for additional production growth. Low cost production in the Montney enables Tourmaline to stay profitable throughout low points in the commodity price cycle. At gas prices of US$1.50/Mcf, Tourmaline’s cash flow covers capital maintenance, incremental production growth and the base dividend.

Company Profile

Prior to founding Tourmaline, CEO Mike Rose founded and led Duvernay Oil Corp, which was sold to Shell Canada ( RYDAF ) in 2008 for $5.9B. Mike Rose and the senior management team are largely the same group who successfully led Duvernay. Management and directors are highly invested in the company with a 6% ownership of outstanding shares.

Tourmaline is a senior Canadian energy producer that is approximately 80% gas-weighted. With 2022 production of 500,832 boe/d, Tourmaline has significant exploration and production operations concentrated in the Montney and Alberta Deep Basin and Peace River plays. Tourmaline is the largest natural gas producer in Canada, and the fifth largest in North America. The company is also a sizeable conventional liquids producer, the largest producer of NGLs, and the second largest condensate producer in Canada.

Tourmaline’s efficiency is enabled by its highly integrated operations that include significant midstream operations. With over 9,000 km of pipelines and interest in 25 gas processing plants with capacity of >2.7 bcf/day, Tourmaline is the fifth largest operator of midstream assets in Canada.

Tourmaline has also developed and spun off a sponsored royalty and midstream operation:Topaz Energy Corp. ( TPZ:CA ). Tourmaline owns a 31.3% of Topaz's outstanding common shares as of September 30, 2022 worth approximately $863M at current prices.

With a market capitalization of roughly $19B, Tourmaline trades on the Toronto Stock Exchange under the ticker "TOU" with daily average volume of approximately 2.4 million shares. Relative to other gas weighted peers, Tourmaline trades at a premium valuation of approximately 4.5X EV/DACF and 4.3X P/CF. With a disciplined capital agenda and very low debt load, the company ended 2022 with 0.3X Capex/cash flow and 0.1X net debt to cash flow.

Results and 2023 Guidance

For Q4 2022 Tourmaline reported production volumes of 511,590 boe/d and CFPS of $4.08. This quarter caps off an impressive year. For the FY 2022 Tourmaline achieved average production of 500,832 boe/d, an increase of 14% over 2021 average production of 441,115 boe/d. Tourmaline generated $3.2B of free cash flow on $4.9B of cash flow in 2022, for FY 2022 CFPS of $14.26.

Tourmaline expects 2023 average production of 520,000-540,000 boe/d with the variance based on down time for permitting. Based on production estimates and current strip pricing, Tourmaline expects cash flow of $4.5B in 2023, yielding free cash flow of $2.6B. Tourmaline anticipates capital spending of $1.675B in 2023 including $100M for exploration and drilling approximately 15 wells. The company noted that it might also direct excess free cash flow to improving margins on midstream investments of acquisitions.

Growth Profile

Tourmaline has dedicated an average of $1.9B in capital annually from 2023 to 2028 to support production growth in the Montney area. Tourmaline projects production growth CAGR 2023-2028 of 6%. The company’s five year capital plan includes the development of its gas and liquids-rich Conroy land in the Northern Montney region. Tourmaline plans to develop Conroy in two phases that will each add approximately 100,000 boe/ with in service dates of 2026 and 2028. These dates are planned to coincide with the projected start up of the LNG Canada export facility at Kitimat, BC. Production in NE British Columbia is constrained by existing egress capacity.

On January 18, 2023, the Government of British Columbia announced an agreement with the Blueberry River First Nation that provides clarity on the development, permitting and execution Tourmaline’s projects in the area. Following a nearly two-year hiatus on new drilling in this area, this settlement opens opportunities for new production activity in the Montney play.

Midstream Assets

Tourmaline estimates that it preserves $350M of cash flow annually by owning its midstream infrastructure. The skeleton of this infrastructure build out is substantially complete and is essentially all new. A 9,200 KM network of pipelines connects production in the Alberta Deep Basin and NE British Columbia plays with marketing egress.

Tourmaline has an interest in 25 gas plants, 15 of which are 100% owned and operated, with four more operated by Topaz. In addition to gas, Tourmaline also owns two oil processing batteries with combined processing capacity of 50,000 bpd. The company owns 10 water recycling plants to support its fracking activities as well as 16 MW of electrical generation and 325,000 of liquids and condensate storage capacity.

The company’s vertical integration and substantial midstream assets provide cash flow stability and preferred egress. These assets could also be spun off in a future value surfacing transaction. Tourmaline may also take the opportunity to surface further value through drop downs with its sponsored vehicle, Topaz.

Returning Capital to Shareholders

In 2022, Tourmaline increased its quarterly base dividend three times from an annualized $0.72/share in to an annualized $1.00/share. In addition to this 39% annual increase on the base dividend, the company paid four special dividends totaling $7.00/share in 2022. All in, Tourmaline paid $7.90/share in dividends to shareholders in 2022, for a trailing yield of 12% based on the average 2022 share price of $66.94.

Tourmaline has committed to returning the majority of anticipated 2023 free cash flow of $2.6B to shareholders. The company is well capitalized to pay further special dividends each quarter in 2023. It is worth noting that the most recent special dividend payable for Q1 2023 was $2.00/ share, down from $2.25 in Q4 2022. This decrease may be an indicator that the pace of growth will be more conservative for 2023. RBC Capital markets calls for two base dividend increases in 2023 (to $1.16/share annualized) on top of $2.00/share special dividends in each of the quarters in 2023. Even if Tourmaline were to keep the current cadence and amounts in place, dividends per share for 2023 would be $9.00, for a 16% yield at current levels.

As I noted in my previous coverage when Tourmaline declared its first special dividend, special dividends allow for capital to be returned to shareholders without committing to long-term increases. This is a prudent approach for businesses that have variable earnings due to commodity price fluctuations.

Tourmaline Dividend Growth Highlights

-5-Year Trailing Base Dividend CAGR of 22%

-Total Estimated Payout Ratio (2023/2024) 75% / 66%

-Free Cash Flow Yield (2023/2024) 9% / 8%

-Dividend Yield (Base/TTM Base + Specials) 2% / 14%

Repurchasing Shares

Tourmaline is approved to purchase up to 16,800,668 common shares for cancellation between August 2022 and August 2023. This would represent approximately 5% of outstanding common shares. Tourmaline will utilize its NCIB opportunistically over this period to capitalized in any share price weakness.

Debt Analysis

Tourmaline expects its 2023 debt to come in below its long-term net debt target of $1.0B-$1.2B, or approximately 0.2X estimated 2023 cash flow. Given that Tourmaline is anticipating ending 2023 with a net free cash surplus of $465M, it would be reasonable to ask why the company needs debt on its balance sheet at all? In 2022, Tourmaline paid approximately $30M in interest on loans and borrowings. In 2021 Tourmaline issued senior unsecured notes of $250M and $200M with maturities of 2028 and 2029 respectively. These notes have fixed interest rates of 2.077% and 2.529%.

For Q4 2022, the average effective interest rate on the company’s combined $737M bank debt and senior unsecured notes was and 3.81%. This compares to an average effective interest rate of 1.64% for Q4 2021. When one considers the cost of equity includes dividends, then this 3.81% cost debt is more attractive than the 12% cost of equity in 2022 ($7.90/share in base and special dividends on an average 2022 share price of $66.94.) In addition to paying additional dividends, issuing new equity would also dilute earnings and be contrary to Tourmaline’s objective of returning cash to shareholders by using its NCIB. Tourmaline is in the enviable position that paying off its debt sooner than needed would actually increase the company’s WACC.

As Tourmaline's effective yield moderates and interest rates rise, the company’s preference for maintaining some debt in its capital structure may diminish. For the time being however, the company enjoys optionality on the composition of its capital structure and WACC.

Tourmaline has ample liquidity with a $2.5B unsecured, five-year extendible revolving credit facility in place until June 2027. Under the terms of this facility, Tourmaline has the option to tap this syndicate of banks for an additional $550M if needed.

Risk Analysis

Approximately 30% of 2023 production is hedged, down from 44% in 2022. With production only partially hedged, Tourmaline’s most significant risk is its exposure to commodity price risk. Tourmaline has an average of 791 mmcfpd hedged for 2023 at a weighted average fixed price of $5.93/mcf. Tourmaline’s detailed hedging schedule is available here .

Tourmaline’s EP program is exposed to drilling and operational risks. The company’s midstream assets help to provide revenue stability. Despite significant 2P reserves, Tourmaline’s reserve are concentrated in plays characterized by relatively high initial decline rates. The resolution of the Blueberry River First Nation in January 2023 clears the company’s most significant regulatory hurdle. Over the long term, production in NE British Columbia could be limited by the development of export facilities. Of the many LNG projects proposed on the west coast of Canada, only two are currently under development.

Note for U.S. Shareholders

Canadian Dividends can generally be sheltered from the 15% tax withholding when held in U.S. retirement accounts. Please consult a tax professional if needed.

Investor Takeaways

With free cash flow guidance of $2.6B, Tourmaline intends to return 50-90% of free cash flow to shareholders in 2023. Investors can anticipate a steadily growing base dividend and special dividends throughout 2023. With high levels of inside ownership, the interests of Management are well aligned with shareholders. The company’s production growth is aligned with the development of LNG export capacity in BC. Tourmaline is a low cost producer with its own midstream infrastructure that has demonstrated profitability throughout the energy cycle. With current softness in natural gas prices, this is an attractive opportunity to buy an investor-focused energy company for a strong total return in my view.

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