Cj update. Thanks to sculpin2 on iv This is from National Bank this morning...
Cardinal Energy (CJ; OP; $7T) is a name we’ve been due for a update with so yesterday we were over to visit with management and walked away thinking perhaps there were some aspects of the story being underappreciated by the market. First, when looking at just a comp sheet on strip pricing, current valuation (5.4x) and relative debt levels (1.8x) maybe misleading as the company echoed they remain on track to execute on previously announced asset sales in 1Q18. The impact of this would see (according to management) their debt drop from ~1.8x D/CF on strip to closer to 1x. And while we don’t have an exact cash flow number associated with the assets up for sale we guess-timate that the subsequent multiple would be closer to ~5x EV/DACF (again assuming strip pricing).
Given relative underperformance of the stock over the last year, what could be some of the factors today holding the stock back at the moment? A few things come to mind:
· We think there is still some optical/sentiment overhang from the most recent financing ($170mm associated with asset purchase from Apache). The degree of this we can’t measure with any certainty, but if in fact this is part of the reason why we’ve seen underperformance it will likely just be a matter of time till the market moves past this (of course aided by operational execution and an improving commodity backdrop);
· Production mix. We’ve seen the differential for heavy blow out noticeably and Cardinal’s oil mix is ~45/55 light/medium-heavy (this will shift to 50/50 by 4Q18 and continue to grow through ‘19). Prior to their most recent acquisition (light oil weighted properties from Apache) the company was generally known as a more medium to heavy grade producer. Management noted the company had 90% of their WCS (heavy) pricing exposure hedged in 4Q17 and for this year 60% of its exposure hedged for the first six months. The company plans to layer in additional hedges for the back half of the year;
· High short interest. As the chart below shows, despite the most recent rally in crude, the company’s short interest has remained elevated. This has likely put additional pressure on the shares even though we’ve seen this short interest retreat slightly;
· A view towards more muted 4Q17 – 4Q18 production growth. However does it make sense, and will the company get rewarded for offering incrementally more growth while trying to manage a sustainable dividend model? Is growth for growth’s sake here just to attract some incremental investor attention the right decision? We don’t mind the view towards a sustainable dividend and a modest FCF yield (4% in ’18 on strip);
Incrementally we took note of:
· Current 8% dividend yield puts CJ in a group of companies who have either just recently cut their dividend or may need to. Which may create some skepticism on the surface that a 8% dividend isn’t implying a cut is needed. But with the company spending <100% (capex + dividend) and sustainable down to <US$50/b we think the ability to service the dividend and meet capex needs internally is perhaps being underappreciated;
· In fact, on strip pricing we estimate the company will generate around $25mm in FCF this year which implies a ~4% FCF yield at the current share price. Debt repayment will be the first priority (company is focused on driving down debt levels well below the 1x target post upcoming asset sales);
· In addition to growing their light stream, capex this year will also target cost saving and efficiency initiatives. While costs this year could be above of $20.50/b, by next year the company sees costs closer to $19/b. For some perspective, each $2 change in the company’s netback equates to $15mm in cash flow on our estimates. So these initiatives aimed at high grading the cost structure (notably driving down electricity costs, which could be difficult as we anticipate AB power costs to potentially triple over the next few years) will help to structurally refine the model going forward;
· Liabilities have been a consideration with this name but management recognizes this and in addition to budgeting for AROs in 2018 is also looking at a number of other alternatives to reduce the overall corporate liabilities (again, aimed at structurally improving the complexion of the business);
· Lastly, the company’s yield model is aided by a low 10% decline rate;
So in summary, we thought we’d flag our notes/thoughts from our visit with CJ considering the company has somewhat been a laggard in this market (and we were due for an update) and we suspect the story as of late hasn’t received the same investor attention as many of the go-to junior/mid-cap oil names in this market. Some aspects to the story here that pique our interest at these levels incl. out of favour name with high short interest in face of what looks to be improving underlying fundamentals (incl. pending asset sales as per management’s guidance), and a sustainable (appears to be) dividend yield of 8% which some investors will find attractive. If anything, we thought worth shedding a light on some of the positive aspects to CJ’s business as a consideration for a levered (operational) idea in a strong crude market.