2023-08-23 10:30:00 ET
Summary
- Q2 results impacted by wildfires, but strong H2 production guidance and favorable oil and natural gas futures curve make NuVista Energy undervalued.
- Majority of production from natural gas, but condensate sales represent about 2/3rd of the revenue.
- Full-year production guidance at 76,000-78,000 boe/day, with potential for increased cash flow due to higher condensate and natural gas prices.
Introduction
As it has been almost a year since I last covered NuVista Energy ( NVA:CA ) (NUVSF), I wanted to bring myself up to speed after the company's second quarter. Q2 wasn't great as the company was impacted by wildfires, but I am quite charmed by the H2 production guidance and the futures curve for oil and natural gas. NuVista appears too cheap thanks to its strong balance sheet and very reasonable sustaining capex requirements.
Wildfires impacted the Q2 results, but I'm still satisfied
Just like so many other oil and gas producers, NuVista had to deal with the impact from wildfires during its second quarter. That's the main reason why the total production rate remained stable on a QoQ basis at just over 71,000 barrels of oil-equivalent per day . That's a good result once you know the company had to shut in about 11,000 barrels of oil-equivalent production in May while several investments in further expansion were also delayed.
As you can see in the image above, the vast majority of the oil-equivalent production is actually generated by natural gas sales but on a revenue basis, the strong condensate prices actually meant about 67% of the revenue was generated from the sale of condensate (which is correlated to the oil price). So 30% of the production represented about 67% of the total revenue and that's why we should look at NuVista as an oil (well, condensate) producer with a substantial natural gas credit and not necessarily as a natural gas producer (although it obviously represents the majority of the output).
The total revenue came in at C$282M and after making the C$21.3M in royalty payments, the net revenue was C$261M. After adding back the (realized and unrealized) hedging gains, the total revenue was C$302M.
The operating costs remain pretty low at about C$188M (and just under C$190M if you'd ignore the small impact from the sale of an asset). As you notice, about 30% of the total operating costs are related to depletion and amortization expenses.
With a pre-tax income of C$114M and a net income of C$87M, the EPS of C$0.40 was very reasonable given the circumstances. Although this result includes about C$41M in hedging gains, there also was about C$30-40M in revenue (and cash flow) losses due to the wildfire-related production curtailments.
The cash flow statement also offers an interesting look under the hood as it excludes the almost C$34M in unrealized hedging gains. And as you can see below, the total operating cash flow adjusted for the C$11.8M investment in the working capital elements was approximately C$146M. After deducting the C$1.5M in lease payments, the underlying cash flow was C$144.5M. This includes a C$6.4M tax recovery so I'll exclude this from the equation to end up with C$138M. Keep in mind NuVista currently isn't paying any taxes as it is using its tax pools but the company now expects to have to pay cash taxes again from 2024 on. If I would include the normalized tax payments (as NuVista will have to start paying them anyway in the near future), the underlying cash flow was approximately C$120M in the second quarter.
As you can see above, the total capex was C$125M which means the company was pretty much breaking even. And while that sounds disappointing, let's not forget NuVista is investing in production growth. The image below (which also provides an operating cash flow sensitivity analysis) shows the sustaining capex is just around C$250M per year , which is C$62.5M per quarter. Applying that average quarterly sustaining capex to the Q2 results would result in a net sustaining free cash flow of around C$60M or C$0.28 per share.
That's still not a great result for a stock trading at around C$12 (indicating it's trading at about 10 times the underlying sustaining free cash flow), but there's more than meets the eye here.
What does this mean for the full-year guidance?
The full-year production guidance currently stands at 76,000-78,000 boe/day. This means that - based on the average production rate of just over 71,000 barrels of oil-equivalent per day in the first semester, NuVista will have to produce about 81,000 boe/day to meet the lower end of that guidance.
And that's exactly what NuVista is guiding for in the third quarter: it anticipates an average production rate of 80,000-82,000 boe/day. That's a 10,000 boe/day increase compared to the second quarter and applying the same operating netback of C$24 per barrel would result in a net operating income increase of approximately C$1.75M per week or about C$22M in additional cash flow during the quarter.
This would result in a quarterly sustaining free cash flow of around C$75M (including normalized taxes on the incremental cash flow) for C$300M per year or C$1.4 per share.
But there is more.
Right now the condensate price is about 10% higher than the realized price in the second quarter of the year and this should boost the revenue. Meanwhile, the natural gas price is increasing as well. And as you can see below, NuVista is able to tap into the stronger natural gas prices on the US markets.
The NYMEX natural gas price during the second quarter was just US$2.10 but the current spot price is US$2.55 while the natural gas price for delivery this winter stands at about US$3.60 for delivery in November-February. At the current exchange rate, that's about C$4.88 per MMbtu. And that makes it a realistic assumption to expect a higher natural gas price as well.
Investment thesis
This means that at the current oil price and forward curve of the natural gas prices, the net operating cash flow will continue to increase. According to NuVista's own sensitivity analysis (based on a relatively low average production rate about 5% below the planned H2 output), the operating cash flow should come in at around C$750M and this should result in a net free cash flow of C$500M on a sustaining basis.
And as you can see in the image above, at $85 oil and $4 natural gas, the free cash flow (including growth capex) should be around C$350-375M. This includes the approximately C$450M in capital expenditures which means the adjusted funds flow would be around C$800M. After deducting C$150M in adjusted funds flow to adjust the oil price downward by $10/barrel and the natural gas price by $0.50/Mcf, the underlying AFF would be around C$650M and the sustaining free cash flow would be around C$400M for a sustaining free cash flow of C$1.85 per share. And as the company has pledged to use 75% of its free adjusted funds flow (including growth capex) for share repurchases, the total share count will likely continue to decrease.
With just C$170M in net debt and a robust production profile, the stock is not expensive from an earnings and cash flow multiple point of view. And the after-tax PV10 of the 2P reserves using an oil price in the mid-80 range and a Henry Hub natural gas price in the mid-$4 range is approximately C$4.87B . After deducting the net debt the after-tax PV10 value is just over C$21 per share. And even if you would apply a 15% discount rate (but simultaneously reduce the share count to 200M shares to reflect the share repurchases), the after-tax PV15 would be around C$17.7. Which means the stock is very appealing right now and you get the exploration upside for free.
I currently have no position in NuVista but I am getting pretty interested at the current share price.
For further details see:
NuVista Energy: Trading At A 15% FCF Yield Using $75 Oil And $3.5 Natural Gas