2023-03-28 13:49:36 ET
Summary
- Frontera Energy Corporation achieved a record-breaking 2022 and returned US$92M to its shareholders.
- 2023 guidance indicates that in the current pricing environment, Frontera Energy will have less room for share buybacks.
- Drilling activities in Guyana are currently ongoing with results expected soon, which may end up being a serious catalyst.
- In terms of valuation, the latest technical report suggests more than 200% upside of the current share price to the estimated after-tax NPV of the 2P reserves.
My favorite type of commodities producer would be one with cash-flow producing assets toppled with significant exploration potential. In the energy space, I've already presented the Africa-focused Africa Oil (AOIFF) as an example of this. I see similar potential in Frontera Energy Corporation (FECCF), which is focused on the LATAM region.
With cash-flow producing assets mainly in Colombia and significant exploration potential in Guyana, Frontera could offer investors a mixture of value and speculative growth opportunity. The company has returned US$92M to its shareholders in 2022 alone, while estimated after-tax NPV of the 2P reserves implies more than 3x potential to the current share price.
2022 highlights
Results highlights (Frontera Energy)
Benefiting from the high oil price environment, Frontera posted total revenue of nearly US$1.3B (+42.1% YoY) with net sales (after accounting for royalties and derivatives gains/losses) about US$1B. The average realized oil price for the year was US$95.42/barrel (+40.9% YoY), while average production also advanced slightly to 41.4kboe/day (+9.4% YoY). The operating netback/boe jumped 60.4% YoY to US$59.78. As a result, the company generated record EBITDA of US$642M (+72.1% YoY) and the respective margin stood at 64.3%.
Shareholder return focus (Frontera Energy)
The cash infusion allowed Frontera to significantly increase its CAPEX to US$418M (+33.1% YoY), while at the same time returned US$92M to shareholders by repurchasing 9.6M shares, which is about 20% of the public free float. It has to be noted that a return of the dividend is unlikely, given that in the Q4 2022 earnings call , management implied that share buybacks are superior from a tax perspective.
Reserves replacement (Frontera Energy)
In terms of reserves replacement, Frontera did a good job yet again, by offsetting the 15.1Mboe extracted in 2022 to a large extent. As a result, the 2P reserves fell only by 3.4Mboe YoY to 174.8Mboe. The reserves' life of the assets stands at 11.6 years as of the end of 2022.
2023 guidance
According to the issued guidance, 2023 production is expected to come in line with the 2022 figure with a midpoint of 41.5kboe/day. However, the oil pricing environment has deteriorated into 2023 and from today's standpoint repeating the average realized price for 2022 looks challenging. Also, the tax regime in Colombia, regarding energy firms, has changed, pulling more money out of companies' pockets if Brent prices are above US$67.3/barrel. This is expected to weigh in negatively on Frontera, and the management expects to generate free cash flow from Colombia and Ecuador of US$50M-US$75M in a US$80/barrel Brent price environment.
2023 guidance (Frontera Energy)
However, this figure doesn't account for the expected CAPEX in Guyana in the range of US$120M-US140M. In other words, 2023 free cash flow could likely be negative, given the considerable capital expenditures. For that reason, I don't think anything close to the US$92M returned to shareholders in 2022 will be seen this year. Share buybacks, if any, will likely be modest.
Expansion opportunities
Frontera's growth path (Frontera Energy)
The significant capital expenditures to be made in 2023 and those already made in the previous years are expected to give a strong boost to production. Under a base case, production rate of over 50kboe/day is expected to be reached in 2025, while additional exploration activities may push it towards the 70kboe/day range.
The Guyana opportunity
Through a direct stake and equity interest in its subsidiary - CGX Energy Inc. (CGXEF), Frontera holds 92.63% consolidated interest in the large Coherent Block in offshore Guyana. The company has already discovered light oil in the Kawa-1 well of the block. And is currently drilling the nearby Wei-1 well. The plans are drilling to be done to total depth of 20.5k feet of total depth with 15.4k feet reached as of 1 March. This means that there's likely going to be an update regarding the Wei-1 well rather soon.
Corentyne block (Frontera Energy)
While the exploration activities in the block are yet to establish resource estimates, it's important to note that the neighboring Block 58 in offshore Suriname holds significant amounts of oil and a multi-billion dollar deal for it was struck between APA Corporation ( APA ) and the major TotalEnergies SE (TTE), regarding that block.
Valuation discussion
Looking at the Forward EV/EBITDA multiples, Frontera appears to be trading in line with the other non-state owned oil and gas companies with a focus on Colombia. While Forward EV/EBITDA below 2 is very low, I think that Frontera could easily trade at a premium to peers, due to its Guyana prospects.
Looking at the latest reserve report , Frontera has after-tax estimated NPV of its 2P reserves of over US$2.4B. At the same time, the current EV of the company is around US$900M. It has to be noted that the calculations used Brent price in the US$80-US$85 dollar range. While this is slightly above the current oil price environment, I think it's not unreasonable to assume that Brent will reach those levels again given the steady increase in demand and the chronic underinvestment in oil and gas exploration and development, during the last decade.
Unit | ||
NPV of 2P reserves | US | 2 416.9 |
Net debt | US | 178.5 |
Implied equity value | US | 2 238.4 |
Shares outstanding | M | 85.6 |
Implied share price | US$ | 26.15 |
Current share price | US$ | 8.42 |
Implied upside | % | 211% |
* Author's estimates based on company data.
Valuing Frontera at the after-tax estimated NPV of its 2P reserves indicates a fair value of US$26.15/share with an implied upside of 211% to the current price of US$8.42/share. Any good news regarding Guyana should act as a solid upside trigger.
Risks
Political risk
The government in Colombia is notorious for its anti-oil stance and the push for the green agenda. In addition to the increased taxes on oil and gas companies, the government announced that it will not approve any new exploration projects. While this is eventually going to hurt the Colombian companies, including Frontera, in the long run, I don't see it as immediate issue. Firstly, existing contracts will be honored and Frontera has plenty of those. Secondly, Colombia is dependent on oil revenues and it's doubtful that the ban will last very long.
Exploration risk
While it's unclear how much, if any, of the Guyana prospect is priced in the current share price, inferior results from the exploration activities there are a serious risk, given the considerable funds that the company is spending on this prospect. The good thing is that even without Guyana, Frontera appears to be undervalued. On the other hand, if significant discovery is made, the upside could be massive.
Oil price risk
As with any oil and gas company, commodity prices are a risk for Frontera. There's a hedging strategy in place, which caps about 40-60% of production to the downside with put options. The 2022 report reveals that hedges extend to May'23 and are for about 40% of expected production with a floor of US$70/barrel. While the hedging strategy itself covers only a few months ahead and will fully expose the company to a potentially adverse oil price movement in H2'23, I doubt that oil prices will fall much below its current levels, especially for a considerable amount of time.
Conclusion
Frontera Energy Corporation offers cash-flow producing assets with a significant exploration potential. While the company doesn't pay dividends, making it potentially unattractive for income-oriented investors, capital is being returned through share buybacks. At the same time, the company is trading at significant discount to its assets in Colombia and Ecuador, without taking into account any potential in Guyana. The after-tax estimated NPV of Frontera's 2P reserves imply 211% upside potential. Meanwhile, positive news from Guyana could act as a serious catalyst for Frontera Energy Corporation to the upside.
For further details see:
Frontera Energy: Undervalued With Potential Near-Term Catalyst (Upgrade)