The MoneyLetter recently reviewed three analysts’ reports from the junior oil and gas stock stronghold of Calgary. These analysts clearly are not just home-town cheerleaders as their ‘hold’, ‘underperform’ and ‘neutral’ ratings will attest.
Obsidian Energy Ltd. (TSX—OBE)
Calgary-based Desjardins Capital Markets analysts Kris Zack and Stephen Swanson came away from oil and gas stock Obsidian Energy Ltd.’s (TSX—OBE) investor’s day feeling concerned about wide oil price differentials and OBE’s ability to boost production in the Cardium Formation in the Western Canada Sedimentary Basin at this time.
“We expect negative market sentiment for lower Canadian oil prices (i.e. the price differential compared to US oil benchmarks) will continue to be a significant headwind for the stock . . . we are lowering our target to $1.15 per share (from $1.75 per share) to reflect lower cash flow estimates in 2019,” the analysts said as they kept their ‘hold’ recommendation.
Management told Messrs. Zack and Swanson they will curtail capital expenditures for production growth during this market of wide price differentials between West Texas Intermediate (WTI), Mixed Sweet Blend (MSW) and Western Canadian Sedimentary oil. In turn, the analysts lower their 2019 estimates for capital expenditures and production. They explain:
“With other minor revisions following the third-quarter 2018 financial report, our funds from operations per share estimate for next year are down roughly 17 per cent. We note our current forecast funds flow of $170 million in 2019 easily covers the $120 million capital expenditure budget, although this is premised on US$65 per barrel of WTI and US$10 per barrel MSW differentials. And year-end 2019 debt levels are still higher than average at 2.7 multiple due to the lower cash flow.
“Plus, wider differentials pressure spending and balance sheet even further. At strip, which currently reflects roughly US$58 per barrel WTI and US$19 per barrel MSW differentials, funds flow falls to just $60 million, and this would put significant pressure on spending and the balance sheet.
“At this point, we ultimately expect that the next wedge of Cardium growth could in part be deferred to the back half of the year, pending visibility on potential improvements in Canadian oil prices.”
Calgary-headquartered Obsidian Energy (formerly Penn West Petroleum) is an independent energy company focused on the exploration and production of oil and natural gas resources in Saskatchewan, Alberta, and British Columbia.
Bellatrix Exploration Ltd. (TSX—BXE)
In late 2017, Calgary-based AltaCorp Capital analyst Thomas Matthews said: “We suspect Bellatrix to outspend cash flow headed into 2018 in order to grow production by five to 10 per cent. . . . In an improving price environment, the added production would decrease leverage ratio without actually decreasing debt.”
Fast-forwarding about a year, Mr. Matthews and fellow AltaCorp analyst Nick Koch say that Calgary-headquartered oil and gas stock Bellatrix once again experienced a cash flow miss, this time in the third quarter of 2018.
“Bellatrix announced its third quarter 2018 results after market close on Nov. 1, 2018,” said the analysts. “Overall, we view this release as neutral with production in-line with estimates, and cash flow coming in below consensus. Management has updated their corporate guidance with lower capital expenditure and higher production; however, we continue to hold our ‘underperform’ rating given our forecasted contraction of available cash flow in 2019 and ongoing risk of refinancing the 2020 term notes. We give the stock a $1.14 target share price.”
Leucrotta Exploration Inc. (TSXV—LXE)
In late November, Calgary-headquartered oil and gas stock Leucrotta Exploration Inc. announced that a drilling program at its Lower Montney Formation horizontal multi-frac well went well. The test rates, in fact, revealed substantial development potential for the company.
The well was considered a major step-out given it was about four miles from any production or tests in the Lower Montney and helped confirm productivity in a material land block owned by Leucrotta north of the Peace River, the company said in a news release.
In a development later in November, the company announced results for the third quarter of 2018. It increased production seven per cent year-over-year to 3,342 barrels of oil equivalent (BOE) per day, increased adjusted funds flow 91 per cent year-over-year to $3.3 million, and maintained working capital of $5.6 million.
Calgary-based CIBC Capital Markets analysts Jamie Kubik and Matthew Little said in a Nov. 28 research note that Leucrotta’s production, cash flow and capital spending all pretty much lined up with projections for the third quarter of this year.
The analysts stick with their ‘neutral’ recommendation but reduce their 12-month target share price to $1.60 from $2. The analysts add that the company’s management plans to safeguard its balance sheet at a time when pricing uncertainty is realistic.
This is an edited version of an article that was originally published for subscribers in the February 2019/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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