- Topaz Energy has a greater chance of success than a typical new company due to the backing of Tourmaline Oil.
- This company is a mixture of midstream and royalty interests.
- The dividend is rapidly increasing, though the payout ratio remains low.
- Both a consistent long-term dividend and debt policy need to be established to the approval of the market.
- The company is likely to trade at a discount to peers until it has been public for a business cycle. New companies often have an inferior performance during cyclical downturns.
(Notes: This article appeared in the newsletter on May 14, 2022, and has been updated appropriately. This is a Canadian company that reports using Canadian dollars unless otherwise stated.)
Topaz Energy ( TPZEF ) (TPZ:TSX) is a new company effectively controlled by Tourmaline Oil ( TRMLF ) (TOU:TSX) that has been public for a little while. The main purpose of the company is to take advantage of the Canadian underserved royalty market and certain parts of the midstream industry as well. The company finances the deals in such a way that it purchases or earns royalty interests as well as some midstream interests without the need to operate the assets or incur the risk of upstream operations.
This company could well settle into an income and growth mode for the long term. For now, though, the company is actively looking for acquisitions while the dividend rises from a very low beginning point.
The backing of Tourmaline should mitigate the risk of a bad deal or for that matter many of the issues that typical startup ventures face. Rapid growth likewise will not be as risky as it is for a typical company because of the backing of an experienced parent company.
Topaz Energy Map Of Basin Operating Areas (Topaz Energy May 2022, Corporate Presentation)
Revenue has been growing very fast. That also means the market will detect a lack of history. Therefore, the stock will likely be discounted to more established peers. As a new issue the stock could also prove to be fairly volatile.
Management has begun to pay out dividends . But it may take some time for the dividend level to catch up to the amount of assets required. This entity intends to have a combination of royalty and midstream interests. Now the midstream part is often seen as the "utility" part of the industry. But the royalties will result in cyclical income as the prices of the production fluctuate. So, this combination of royalties and income will be more volatile than midstream and probably less volatile than a royalty company throughout the business cycle. The market may need some time to get used to this as it is not a very common combination.
The other consideration is that the midstream entities traditionally carry more debt than just about any other part of the business because their business is so predictable. Therefore, it will be interesting to see a long-term debt strategy (not just right now) for a company like this one that is a mixture of midstream and royalty.
Topaz Energy Description Of The Significance Of Clearwater Interests (Topaz Energy May 2022, Corporate Presentation)
Probably the company's most visible asset is the interest obtained in the Clearwater play. This is one of the most profitable deposits in Canada. Hence it is likely to be developed at a rapid pace. Since the market generally likes easy answers, this one holding may be responsible for a fair amount of continuing goodwill in the stock price. This area is one of those "everyone knows" how profitable the area is along with the mad scramble to obtain acreage and develop it. Sometimes a holding like Clearwater royalty interest makes or breaks an investment decision over other players with lesser-known holdings.
This company provides a less risky way (than a typical upstream strategy) to participate in a rapidly growing basin that is known to be very profitable. The royalty part of the holdings will probably grow as rapidly as the projected growth on the applicable leases (that is very rapidly, by most reports).
Topaz Energy Details Development Commitments That Increase Royalty Income (Topaz Energy May 2022, Investor Presentation)
One of the differentiating characteristics about the royalties purchased has been the underlying commitments by companies to develop the land. There are a lot of royalty companies that own an interest over a tremendous number of acres with absolutely no idea when or if the acreage will produce oil and gas. This company tends to purchase acreage for a royalty interest that "will" be developed. Of course, there is always a risk that commodity prices go so low that the company backs out of the capital budget commitment. But at least for the time being, management appears to be purchasing acreage with a competitive advantage that ensures priority development.
Topaz Energy Return On Cash Invested As Management Sees It (Topaz Energy May 2022, Corporate Presentation)
The company appears to have a great start on the profitability of these investments. Many investors will not consider this stock properly seasoned until they see the performance of the company during the next industry downturn. Therefore, the stock could trade at a discount to other Canadian peers until the company has been public for a full business cycle. For the same reason, the stock could suffer a larger drop in value than investors expect during the next cyclical downturn.
The last consideration is the long-term strategy that management chooses to return capital to shareholders. This is a startup company that continues to purchase interests at a pretty good pace. So, the question should be about how long the market will "put up" with the growth story rather than insisting upon the usual rate of return of either a midstream or a royalty company.
If the market continues to accept the current mode of operation, then the company could grow quickly and so could the dividend. The payout would remain atypically low. But the market often forgives a lot in return for fast growth. Such a strategy would incur a risk surrounding the end of fast growth that any potential investor would need to answer before investing.
The Future for Topaz Energy
Topaz Energy is off to a good start as a public company. The company occupies an underserved area of Canada by monetizing royalty and midstream interests. As such, management is likely getting a good deal for shareholders and will likely continue to get a good deal for shareholders until more of these companies compete for the same projects.
The current yield on the stock is low but fast growing. There is also a lack of public history. The backing of an established company like Tourmaline should minimize a lot of new company (and lack of management depth) risks. But there is no guarantee of a favorable investment outcome.
Finances appear to look pretty good right now. The question is whether or not management will be tempted to "stretch" in the future. There needs to be an appeal to a consistent investment audience to assure a reasonably long-term stock price that is stable. Mr. Market just hates strategy changes. While that is likely to happen, there is not yet enough history as a public company with established quarterly results to be sure.
For those that can handle the extra risk, this company may be a decent, if somewhat variable, income play. The level of long-term capital from reinvested cash flow remains a question until a few years pass. Managements, particularly managements of newly public companies are a little more prone to change their minds. There will likely continue to be capital appreciation in the short-term as the company gets established. But there is also likely to be a long-term strategy of mostly income with some capital appreciation.
For further details see:
Topaz Energy: A Little More Growth Than Usual