Net debt decreased to $62.7 Million YoY, leading to a net debt to FFO of 0.18x.
2022 profitability is unlikely to be repeated in the lower commodity price environment.
Using conservative estimates, YGR still trades at 4.14x 2023 FFO, and its monthly $0.06/share dividend is well covered.
The 10% dividend yield is safe.
All figures are in CAD unless otherwise noted as that is the company's reporting currency.
Introduction
Those who follow my work may recall that I recently wrote on Yangarra Resources ( YGR:CA ) Yangarra Resources: Absurdly Cheap which I suggested was of tremendous value despite weakening commodity prices. I present to you now another juicy alternative in Cardinal Energy ( CJ:CA ) which is also a Canadian junior E&P company based in Calgary, AB.
CJ is equally invested in light and heavy crude oil production which combined makes up 84% of their portfolio. They are invested in low decline assets with the base decline at less than 10%. Majority of production is under established secondary or tertiary recovery schemes. This is known as Enhanced Oil Recovery ((EOR)) which is known for being complex and expensive. These techniques are typically only employed when the primary and secondary recovery techniques have exhausted their usefulness. One way to extract involves injecting gases (CO 2 ) into the well in a way that both forces the oil to the surface and reduces its viscosity. The less viscous the oil, the easier it flows and the more cheaply it can be extracted. The other is pump steam into the well in order to heat the oil and make it less viscous. CJ's portfolio has an estimated remaining useful life of just over 12 years.
Cardinal Energy (March 2023 Investor Presentation)
Despite inflationary pressures which pushed up labour and power prices in fiscal 2022, CJ's operating expenses were less than $25/BOE which rivals even the Canadian supermajors such as Suncor ( SU:CA ), Canadian Natural Resources ( CNQ:CA ), and Imperial Oil ( IMO:CA ).
Fiscal 2022
Like most E&P companies, CJ had a record year in fiscal 2022 in terms of production, revenues, and netbacks. Highlights include:
Increased adjusted funds flow for the fourth quarter of 2022 and for the fiscal year 2022 by 28% and 174% respectively YoY;
Production increased by 10% YoY while petroleum and natural gas revenue increased 66% in 2022 compared to 2021;
Increased the monthly dividend to $0.06 per common share in the fourth quarter of 2022 bringing the current dividend yield to 10%;
At the end of 2022, net debt decreased to $62.7 Million, a 65% decrease over the balance of $178.2 Million at the end of 2021 leading to a net debt to adjusted funds flow ratio of 0.18x;
The final point may be the most heartwarming as theoretically if commodity prices hold up they could cover their debt with 2023 FFO. The main driver for the higher FFO was both high commodity prices but furthermore the exposure to West Canadian Select Pricing on light oil production which exceeded $100/bbl for much of 2022.
Despite YGR having a record year in fiscal 2022 the share price has declined ~7% since its fiscal YE although the decline has not been as bad as YGR or IPO. YGR has taken a beating more so because of its higher natural gas exposure and leverage as natural gas has taken a beating is recent months. CJ is only 16% in natural gas and only 4% in natural gas liquids so its revenues will be much less impacted by the fall in natural gas prices. Much like most of its peers CJ has chosen to remain unhedged for fiscal 2023 with the exception of a January fixed WCS differential contract for 2,500 bbl/d which is negligible. CJ has chosen to remain unhedged due to the backwardated commodity pricing curve. The lower debt levels and planned expenditures may not make hedging expenses necessary however.
The management budget is unfortunately based off stale pricing ($80/bbl WTI, $3.50/mcf AECO USD) which is too optimistic in today's climate. I alluded to the EIA's revised forecast for 2023 and 2024 in my previous article but restate below. Essentially the supply in the market is catching demand and therefore higher oil prices that were seen in 2022 will likely not persist.
U.S natural gas consumption would average 99.1 billion cubic feet per day, down 5% from 1Q22 due to milder temperatures that have reduced demand for space heating. Residential and commercial consumption would fall by 11% YoY. Global liquid fuels consumption would increase by 1.5 million barrels per day in YoY and by an additional 1.8 million b/d in 2024. China is the main driver of growth in 2023 as the country shifts away from its zero-COVID policy. Russia recently announced a crude oil production cut of 0.5 million b/d for March, and we expect declines to be more than that, with Russia’s production falling by 0.7 million b/d in March. Despite the declines in March, recent petroleum exports from Russia have outpaced expectations, and we have revised our oil production forecast for Russia upwards by 0.4 million b/d in 2023. Overall, we expect global oil and liquid fuels production will average 101.5 million b/d in 2023, up 1.6 million b/d from 2022.
Management has valued their total proved reserves on an after tax basis at $1,223 Million or $7.89/share which is 10% higher than the current share price of ~$7.20. 87% of reserves are proved producing. The assumptions might be a little aggressive even with the backwarding for 2023-2026 as the even Brent Crude is currently at only ~$75/bbl. AECO prices haven't been over $4/mcf all year.
2022 Annual Information Form (Cardinal Energy)
2022 Annual Information Form (Cardinal Energy)
That being said even at today's prices, I see CJ as a good income investment with its 10% yield. Using more conservative pricing assumptions below, most notably WTI prices of $70/bbl and $2.75/MCF AECO, I estimate a ~$35/BOE operating netback, $267 Million in FFO, and FFO of $1.72/share for 2023. Please note my estimates do not take into account the WCS or MSW differentials which have a $4.6 Million and $1.4 Million Delta on FFO.
Also fiscal 2022 saw extreme monthly variability in average Alberta power prices of $75-312/MWh (2022 annual average ~$162/MWh) resulting in operating expenditures associated with power ranging from $6-12/BOE on a monthly basis ($8/BOE average). CJ has added significant fixed price power contracts covering the majority of forecasted Alberta usage from 2023-2027. 72% of 2023 forecasted power consumption covered by fixed price contracts to average $85/MWh or $6-$8/BOE on a go forward basis. 26% of these commitments are for 2023 which is taken into account in my forecast.
Q4 2022 MD&A (Cardinal Energy)
Author Table (Company Filings)
Key takeaways:
Pricing/BOE will be in line with fiscal 2021 in the lower commodity price environment and the stagnant production (2.2% expected increase) will result in FFO declining as much as 22%.
FFO should more than cover planned CAPEX, debt repayment, and ARO. The dividend payout ratio would still be modest at ~42%. Increased shareholder returns is unlikely as the budget is already tight with lower commodity prices.
CJ stock would still be cheap at 4.14x FFO and its leverage would still be low at 0.23x.
Author Table (Company Filings)
March 2023 Investor Presentation (Cardinal Energy)
The capital budget for next year looks to be 45% geared towards maintenance capital expenditures/ARO which will not increase production for future years. It is unclear how much the 6 new horizontal wells at Clearwater and two at Dunvegan will increase production in future years or how much general optimization will increase production in the near-term so expecting flattened production over the next couple of years is not unreasonable. That being said prioritizing debt repayment and shareholder returns in the current environment is not a deal breaker as long as the production is reliable which is very much the case with the RLI of 12 years and recycle ratio of over 5%.
2023 Q4 MD&A (Cardinal Energy)
2023 Q4 MD&A (Cardinal Energy)
Conclusion
Although the commodity bull run witnessed since the end of 2020 may have stalled out and fiscal 2023 may not be as strong for CJ, the junior E&P company can still produce massive profits at current prices. Although CJ is very cheap, relatively speaking compared to its peers is actually the most expensive. CJ is by far the highest dividend payer and its FFO well covers its debt and CAPEX, so makes for a much better income investment and should provide reliable returns in the currently volatile commodity environment.
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