AETUF - Why ARC Resources Should Deliver Good Results

Summary

• Economists are expecting a rebound in crude oil and natural gas prices, providing a favorable framework for ARC Resources.
• The Canadian crude oil and natural gas producer is enjoying strong operating momentum.
• The stock is poised to continue producing good returns while offering a significant margin of safety.

ARC Resources Ltd Performs Well as Oil and Gas Prices Rise

Intense speculation in the fossil fuel markets has not only pushed commodity prices to historic highs but has also led to significant price increases for listed producers. ARC Resources Ltd. (AETUF) shareholders also appreciated the rise in crude oil and natural gas futures through a few important rallies in the share price of their stock in the past 12 months, as shown in the chart below.

The shares of ARC Resources Ltd. are poised to show more upside as company activities continue to benefit from commodity prices which are expected to trade higher going forward. In addition, the stock price appears to be trading at the bottom of the cycle, so investors may want to buy shares to take advantage of a cheap entry point considering the possibility of the next rally.

The chart also shows a positive correlation between ARC Resources Ltd. and Crude Oil WTI Futures - Mar 2023 (CLH2023), the benchmark for crude oil prices. This makes it more likely that any future AETUF stock price increase will be through crude oil and not by natural gas, with which AETUF instead shows a significantly smaller correlation. Natural Gas Futures - Mar 2023 (NGH2023) is the benchmark for natural gas prices.

Fossil Fuels: Current Trends and Expectations

Speaking of natural gas futures in the US, current market prices are nearly four times lower than an all-time high of nearly $10 per million British Thermal Unit [MMBtu] in mid-August 2022. This peak was reached due to concerns about the regular supply of the commodity following the Russian occupation of Ukraine.

Since the peak, most of these fears have dissipated as Europe became more independent from Russian fossil fuels, with natural gas gradually falling to $2,722 per MMBtu at the time of writing.

Crude oil prices have also experienced a strong downward trend, moving from a price above $120 per barrel in early June 2022 to the current price of $78.94 per barrel.

However, the downtrend should soon give way to a rebound in crude oil and natural gas, as economists are predicting higher commodity prices as early as this quarter. This is because fossil fuel demand should get a boost from the following drivers: a much less-than-expected slowdown in the economy despite central banks' aggressive stance on soaring inflation and China's strong recovery after the government ended its zero-COVID-19 tolerance policy.

Economists, therefore, expect natural gas to rise 12% to $3.04 per MMBtu this quarter and 37% to $3.71 per MMBtu by the end of this year, from current levels.

Economists also expect crude oil to rise 5.3% to $82.85 a barrel this quarter and 18.5% to $93.15 a barrel by the end of this year, from current levels.

About ARC Resources Ltd. in the Oil & Gas Exploration & Production Industry

ARC Resources Ltd. based in Calgary, Canada, is a hydrocarbon-producing company active in Canada.

The product comes from the exploitation of certain crude oil and gas properties that the company is operating in the North American country.

Specifically, these mineral properties are the mineral formations of the Montney properties which are located in northeast British Columbia and northern Alberta.

The company's oil equivalent reserves are estimated at approximately 930 million barrels in proven and probable reserves.

How ARC Resources Ltd is Performing

In terms of gross production, ARC Resources mined 340,855 barrels of oil equivalent per day [boe/d] in the first three quarters of 2022 , reflecting an impressive 18.7% year-on-year growth.

Natural gas contributed 60% while crude oil and liquids accounted for 40% of total production.

From selling one barrel of oil equivalent during the first three quarters of 2022, ARC realized an average price of $63.89, up almost 70% from $37.67 in the same period of 2021. After operating costs, transportation costs and royalties credited to other operators, the average realized price increased nearly 70% year-over-year to $44.09 per barrel of oil equivalent sold in the first three quarters of 2022.

Higher production and prices enabled the company to raise funds from operations in the first three quarters of 2022 that reached CA$2.73 billion or US$4.04 per share, a strong improvement over CA$1.58 billion or US$2.3 per share in the corresponding period in 2021.

Free cash flow grew 86.6% year-over-year to CA$1.67 billion or US$2.47 per share in the period under review.

The Company Returns Significant Free Cash Flow to the Shareholders

The increased free cash flow has enabled the company to pay higher dividends to shareholders, fund buybacks of common stock, ensure a good financial condition and fund projects for higher oil-equivalent production in 2023.

ARC Resources has very good profitability of its business on a relative basis, as evidenced by a 12-month leveraged Free Cash Flow [FCF] margin of 22.24% versus the industry median of 6.73%. The past 12 months versus a 5-year average of 8.55% is evidence that the company has strong positive momentum that investors should not ignore, but try to capitalize on, as this could potentially lead to higher share prices from current levels.

ARC Resources notes that the dividend grows in line with the company's underlying profitability, which, combined with the board's policy of reducing the volume of outstanding shares by buying back its common stock, creates a sustainable payout throughout the commodity cycle.

The dividend is paid by the company every three months, but on a 12-month basis, the payment increased by 70.3% year-on-year to CA$0.49 per share in 2022. The last quarterly distribution was issued on January 16, 2023, and resulted in a forward dividend yield of 3.80% as of this writing.

Since September 2021, when ARC Resources began share repurchases, approximately 13% of outstanding shares, equivalent to 93.1 million shares of common stock, have been withdrawn. The common shares were repurchased at a weighted average price of $15.12 per common share.

Company Expectations for Production and Free Cash Flow

Fueled by growth at the Kakwa project in Alberta, where the company is benefiting from strong drilling results (despite increased drilling distances) and efficient wells management, the company expects to increase average production by 2-3% year-over-year to 350,000 barrels of oil equivalent per day by 2023.

While this level of production should be confirmed in 2024, funds allocated for capital expenditures are expected to decline from CA$1.8 billion in 2023 to between CA$1.5 billion and CA$1.6 billion in 2024.

ARC Resources believes the mineral operation can generate CA$ 1.7 billion in free cash flow by 2023, which will be in line with the first three quarters of 2022.

The Financial Condition

As of September 30, 2022, ARC Resources' balance sheet appeared resilient, although net debt of CA$1.5 billion is on track to reach 1 to 1.5 times funds from operations up from the current 0.4 times funds from operations.

The debt, which long-term position is 90% corporate loans and 10% credit facilities, implies an interest expense that is more than offset by operating income, meaning the company has no trouble servicing that debt. This financial attitude toward paying off debt is measured by the interest coverage ratio, which, as the ratio of 12-month operating income of CA$2.8 billion to 12-month interest expense of CA$96 million, is 29.2 times and significantly higher than the generally accepted 1.5-fold.

An Altman Z-Score of 2.66 also indicates solid financial circumstances, although a small risk of insolvency cannot be completely ruled out. However, the company's balance sheet is very close to safe zones, implying no risk of bankruptcy.

The Stock Valuation

The shares of ARC Resources Ltd. were trading at $11.62 apiece for a market cap of $7.14 billion as of this writing.

Compared to recent market valuations, shares are trading low as they are below the 200-, 100- and 50-day simple moving average lines and below the midpoint of the 52-week range of $10.38-$18.23.

Shares are not only very low but also cheap given the positive catalysts of higher fossil fuel prices and production for 2023.

The company says it buys its own shares when the market price drops below its intrinsic value, which is calculated as the present value of future cash flows. As prices and output are expected to be higher in 2023, the current stock price of $11.62 (it is 23% lower than the $15.12 average of past buybacks) is most likely still below this stock's intrinsic value.

Analysts at GuruFocus have provided a measure of AETUF's intrinsic value through a valuation model called the "Projected FCF Model", which is preferable to a discounted cash flow model based on free cash flow or revenue because AETUF's revenue and cash flow are difficult to predict. As a result of applying the projected FCF model, the intrinsic value of AETUF is $14.02 , which gives a margin of safety of approximately 17% compared to the current share price.

ARC Resources Ltd. also trades on the Toronto Stock Exchange under the symbol ( ARX:CA ) with shares priced at CA$ 14.89 per unit and a market capitalization of CA$ 10.28 billion as of this writing. The stock has a 50-Day Moving Average of CA$ 17.59 and a 200-Day Moving Average of CA$ 17.77. Also, the stock has a 52-week range of CA$ 13.65 to CA$ 22.88.

There is a risk that the stock will not perform as expected, but that is small as company conditions are good while macroeconomic and geopolitical factors support higher crude oil and natural gas prices.

Conclusion

ARC Resources Ltd. ' s operations are in a strong momentum and this factor combined with the expected increase in fossil fuel prices should be very positive for the stock price.

Shares look cheap and investors should take into consideration to increase their position from these levels of price as a Buy rating today suggests there is potential for very good returns on this investment.

For further details see: