February 1, 2022
Headwater Exploration Inc. Exploration Hits Pay Dirt
Our view: Headwater provided a Q4 operational update inclusive of several strong exploration well results and a material uptick in Clearwater exploration land around the core Marten Hills block. Despite any material transactions to date, we see the organic derisk and exploit model providing significant upside with 2022 set to be a pivotal year. We reiterate our favourable view and have increased our target to $8.50/share from $7.50/ share.
Key points:
Exploration hits pay dirt. The company drilled two successful 6-lateral exploration wells targeting the Clearwater A (predominant over HWX exploration land). The first (11-05) exhibited an IP31 of ~275 bbl/d (21 degree API) with the second well (13-07) exhibiting an IP19 of 215 bbl/d (19 degree API). The company also drilled one 8-lateral well (08-34) into the Clearwater B (Western block), which exhibited an IP42 of 155 bbl/d (19 degree API). All three wells screen at or above our exploration type curve (150 bbl/d IP30) and confirm economic pools (Exhibit 1). Management plans to drill two stratigraphic tests and two follow-up locations in the 'A' and one follow up well into the 'B' during Q1/22.
2022 guidance increased following exploration success. Management has increased 2022 capital guidance to $145 million to incorporate recent land acquisitions (added ~70 net sections) and drill 4-5 new exploration wells late in the year (24 expl/dev wells total). Production guidance was left unchanged at 12,500 boe/d (15,000 boe/d exit) with incremental production from additional wells expected to impact 2023 numbers.
Estimate changes - incorporating Q4 actuals, exploration upside. We have updated our model to reflect Q4/21 volumes of 10,400 boe/d (in-line with current consensus) in addition to management's updated outlook. Our production estimates are roughly flat in 2022E, increasing 3% in 2023E as added exploration capital is expected to be deployed late in the year. Accordingly, CFPS increases by 5%/3% in 2022E/23E (Exhibit 2).
Balance sheet - building dry powder. Headwater does not currently have a revolving credit facility in place, though we see the company building a net cash balance of $170/$273 million in 2022E/23E. In our view the company remains well positioned to execute on strategic M&A if opportunities arise, though not a requirement given a sizeable exploration portfolio. Management may also consider return of capital strategies over time if a use of cash is not identified.
Outperform recommendation. We reiterate our Outperform, Speculative Risk rating and increase the target price to $8.50/share. We believe Headwater offers significant exploration driven upside, operating in one of the most economic resource plays in Western Canada. Additionally, we view management’s record of value creation and conservative operating model favourably with the company well positioned as a regional consolidator.