2023-06-09 16:17:07 ET
Summary
- Headwater Exploration Inc. management keeps reporting new discoveries to enlarge the company future.
- The debt-free balance sheet with a large cash balance protects against potential downside stock price moves.
- Heavy oil discounts often widen during commodity price downturns.
- The conservative management long-term guidance typically is revised upwards for the next fiscal year at the end of the current fiscal year.
- Management experience building and selling companies is a huge plus.
Headwater Exploration Inc. ( OTCPK:CDDRF ) management has long been very conservative about the future. This is because of the low visibility of the future as well as the tendency for heavy oil discounts to widen during times of weak commodity prices. But as long as the company remains debt-free and commodity prices cooperate, this company should have a very good future as long as the discoveries continue to parade in periodically.
Operations keep expanding as management adds acreage on a steady basis while reporting the latest discoveries. Those discoveries enhance the long-term growth outlook. Generally, management will only long-term forecast anything that is already producing and can be relatively cheaply expanded. That is a "just in case" low expectations forecast.
The real outcome is likely to be better as long as expectations of liquids prices strengthening the second half of the fiscal year hold up. Even should the worst happen, and a recession rears its ugly forecast, recessions typically do not last all that long and are not all that damaging. The current economic activity levels are "sky high" with record job creation. A slowdown from those levels that meets the official definition of a recession would be a recession with an unusually high level of economic activity. Believe me, it could be far worse than that.
The risk of this predominantly heavy oil play is that weak liquids pricing would cause the discount to light oil WTI pricing such that production would have to be shut in. Management does not want to give an ambitious growth projection into the future when there is a risk of no growth from such a scenario. Instead, management has given a conservative future projection that factors in a rough economic quarter or two so that guidance can be updated in a positive direction.
Investors, need to keep their eyes focused on the company balance sheet (remaining debt free) and the steady parade of economically viable discoveries like the ones shown above. As long as that is the case, then the growth future here is likely to rival some of the "one decision" stocks, but at an out-of-favor oil company stock price valuation. That is very likely to provide a far greater chance of a return to normal industry growth valuations in the future from the currently distressed valuations levels (when there is no distress).
Many investors do not realize that a typical company reserve report only represents the oil that can be currently produced economically. Sometimes that economically part is abused too. There is actually many times more oil in the ground that is not considered economical at the time of the reserve report. But as technology moves forward, recovering at least some of that oil often becomes economical. Many times, current technology allows anywhere from say 7% to in some cases more than 40% of the oil in place to be produced. But those recovery percentages do manage to grow over time.
In this case, the initial discoveries head to secondary recovery with water flooding pretty quickly. Secondary recovery often has much lower decline rates than just about any other type of recovery. That is especially true when compared to the usual conventional or unconventional. That means that once the initial capital is spent to begin a waterflood project, the maintenance capital required to keep production level is low.
What is unusual here, is the very low cost of secondary recovery through waterflood. In the United States, many of these secondary recovery projects are expensive. As a result, they are often shut-in during cyclical downturns when commodity prices are weak.
But so far, the Clearwater numbers appear to have a very unusually low breakeven point. This points not only to lower costs, but also the possibility of production continuing during periods of weak commodity prices even if the heavy oil discount widens. That could make this one of the lowest cost basins in North America.
Management will update guidance based upon the strip pricing. These updates typically affect the capital budget. As long as the cash is there for the capital budget, then things are unlikely to change materially. However, should the strip pricing fall to the point that the cash balance declines materially, then management will act to keep a safe amount of cash on hand.
Heavy oil has long been a discounted product. Therefore, a company producing such a product needs to be able to make it through cyclical downturns with production shut-in due to extremely low realized prices.
Somewhere in the future, it may be possible for the company to diversify into a light oil play that would minimize that cash balance need. But for the time being, that does not appear to be a consideration.
Management has initiated a dividend to cater to the market demands of a return of capital. But the return on current projects appears to give the projects a higher priority than the dividend. Therefore, income investors probably need to look elsewhere as this will likely remain a largely appreciation vehicle for the foreseeable future.
Progress made in the current year to an exit rate will largely determine the revisions made to the long-term guidance for the next fiscal year. Should commodity prices unexpectedly weaken (and stay weak), then the capital budget would be adjusted downward to result in a lower exit rate for the current fiscal year.
Right now, it would appear that the exit rate will be at least 20,000 BOED (which is mostly heavy oil). That would likely allow the rise of the next year guidance at least 2,000 BOED. But the low visibility of this industry is what is causing management conservatism.
The map of operations shown above has plenty of space that is not yet leased. Therefore, there could well be plenty of acreage yet to be acquired at a reasonably low cost. The steady reporting of discoveries also implies a lot more potential ahead for this basin.
This management has a lot of experience building and selling companies. That somewhat limits the risk of rapid growth. This is essentially a new company because the discovery is so large compared to legacy operations and is also very different from the legacy natural gas business. That makes that management experience essential.
The Headwater Exploration Inc. debt-free balance sheet with the relatively large cash balance should likewise limit the downside risk of this investment. Financially strong companies usually get to try again to succeed (if they need the chances). But leveraged companies have to hope things go as planned. In a low visibility industry like this one, surprises are common. Therefore, a conservative balance sheet and debt ratios are essential to succeed.
For further details see:
Headwater Exploration: Discoveries Ensure Healthy Future