Q3 ReflectionsReflecting upon the Q3 release.
Maybe I'm like you, maybe not. When new information like the recent Q3 is released, I already have predicted numbers.
First I read the NR as quickly as I can to see how the actual numbers compare to what I thought they might be. When they are off, I look to see why. I then decide if the reason why is isolated and temporary, or long term.
Delays are disappointing, but don't warrant a change in plans. Long term changes mean deciding if I should be changing vehicles.
My first read told me this was a timing related delay. A disappointment that would likely cause some market turbulance. But turbulance that would likely pass after a few days.
Once the initial turbulance fades, its time for reflection and a second look.
It looks like the turbulance is over, so time for another look at the NR.
My investment thesis is OBE pays down debt and grows production going into an increasingly tight macro oil environment. ie a virtual circle - production increases while oil prices increase...........resulting in cash flow increasing two times at once, and increased cash flow ratios caused by declining risk (reduced debt).
In basic finance terms - Maximium present value growth by increasing the numerator while concurrently reducing the disount rate.
OBE has given us a $225 million debt threshold. ie, all extra cash (after their growth activities), will go to paying down debt, until it gets to $225. Thereafter some proportion of extra cash will be returned to shareholders.
OBE has been clear that if the share price is low, the amount returned to shareholders will first be via share buy backs.
I prefer dividends over buy backs. But OBE is an exception. Becuase of the 7 for 1 reverse split it did a number of years back, it has relatively few shares outstanding (just 82 million).
The annual share buy back limit is 10%, so they can only buy 8 ish million shares back. After that, their only option is dividends. Its that dividend I'm waiting for.
I'm expecting them to have enough free cash flow to maximize their share buy back, and still have lots more to pay a meaningful dividend. (thanks in large part to their current policy of maximizing growth).
The fact that they will be paying that dividend to 10% less shareholders is a nice bonus - ie the dividend will be 10% more than otherwise.
I don't know what their free cash flow pay out ratio will be - some companies are paying 75% or more. I'm assuming 50%. ie, from their operating cash flow, they first substract Capex, then they split whats left in half - with half staying within the company and half being paid out to shareholders.
Given this investment thesis, my focus is cash flow.
The more cash flow they have, the faster they pay down debt, and the faster they get to the $225 million threshold.
After that the more cash flow they have, the faster they buy back 10% of their shares, and the faster they start paying a dividend.
The more cash flow they have, the bigger that dividend will be.
The bigger the dividend, the bigger the share price will be.
Is all about the cash flow.
Now for the reflection. What did the Q3 NR say that affects the above?
Their new forecast uses $90WTI for the rest of Nov and Dec.
Importantly they do not reference a CAD/USD exchange rate. The only exchange rate reference I can find is in their presentation - it is older, and is 1.26 cad/usd (page 21 of presentation, when discussing 2021 reserves). The current exchange rate is 1.33. That is 5% more. That 5% difference may translate into an extra 5+ million in Q4 cash flow.
Using only OBE's NR forecast for Q4, we see they are now forecasting zero debt being paid down during Q4. ie, ending Q4 with $327 million in net debt.
This Q4 zero debt reduction is based on 33,000 boe average in Q4 and WTI of $90 (with an unknown exchange rate).
Zero debt reduction in Q4 means they forecast having no Q4 free cash flow (after capex).
We also know from the NR they are forecasing $325 million in capex during 2022. We know they spent $144 million in H1 and $74 million in Q3. That means $107 million in capex in Q4.
$107 million capex in Q4 is more than I was expecting. Some of this increase is from higher costs, but the rest is because they are doing a lot of drilling. More drilling in Q4 means more production in 2023, and more cash flow in 2023.
Reflection 1.
If WTI stays at $90 average in Nov and Dec, OBE will not hit their $225 million debt target by year end. In fact they will be $100 million away from that level by year end.
Reflection 2.
If WTI is higher than $90 in Nov and Dec, then the extra cash flow will be used to reduce debt.
Every US$1 over $90 for WTI in the remaining Nov and Dec, probably adds about $1 million in cash flow. ie, if WTI were to average $100 over the remaing weeks of the year, this would mean about $10 million in debt reduction. $110WTI, would mean about $20 million in Q4 debt reduction etc.
The price of WTI in Nov and Dec is anyone's guess. Any one of a number of events could push oil up over the last weeks of this year. I don't know what it will be, but I think it will be higher than $90. The US midterm elections are now over, there is no advantage to Biden to keep draining the SPR. Winter is starting. Russian oil production is declining. US refinaries are restarting after shoulder season maintance - ie more oil demand. Potential for conflict caused production interuptions in Libya, Saudi Arabia to name a couple.
I think they are low with their $90 WTI forecast for the rest of the year. A higher number means they beat their latest forecast, and get closer to that $225 debt number.
Reflection 3.
Raising capex yet again, to $107 million in Q4, and zero Q4 debt reduction, means OBE is really determined to increase its production. Maybe they don't want to give up a rig, or maybe they have some other reason to spend every last penny to maximize their production! Is this evidence of intent to sell as soon as possible - ie grow production and sell the company based on $ per flowing barrel? Its an uncommon strategy right now. Others seem to be more interested in maintaining production, or added minor growth, then using whats left to pay debt or dividends.
Refection 4.
They are testing various locations on thier peace river land, with highly variable results.
They drilled 10 unimpressive Peace river wells.
8 of these 10 were close together on the East side of their land producing at just 750 boe together. They are making money, but they are 1/3 of what I was hoping for.
The other 2 are to the west of two previously drilled good wells, and they are very poor, at just 32 boe/day for the two. Looks like they found the western edge of that pool. These two duds played a role in the reduced 2022 production guidance.
They are going to drill three more pads in different locations - hopefully they will come in better.
Maybe that batch of 8 was bad luck. OBE said they came on as expected. They may of been as forecast, but I was hoping for more. OBE isn't drilling any more in that area, so I suspect they are hoping for better elsewhere too.
Reflection 5.
I really like that they are presently producing at 33,000 boe and they are forecasting for a bit higher for a Q4 average. We don't know the Q3 exit prodution, so can't estimate the Q4 exit rate. That said, I think it will be around 35,000 boe - ie exited Q3 at about 31,000 boe; exit Q4 at about 35,000, meaning a Q4 average of 33,000.
Reflection 6.
I think they will exceed their current Q4 forecast. They are spending about $180 million in capex in H2. They may of missed out on the first month of drilling, but that much capex has catch up potential. What extra production doesn't show up in Q4, will show in Q1/23. Their prior 2023 forecast was 37-38,000 boe and was based on $95WTI.
Their 2023 forecast is impressive - $374 million in free cash flow. That is based on $95WTI. Personally I expect WTI to be higher in 2023. You can do your own sensitivity analysis to the free cash flow number at higher WTI prices, like $100, $110, $120, etc. You'll see it doesn't take much of an increase in WTI to double that free cash flow number.
And that free cash flow is what is going to decide the dividend size mentioned in my above investment thesis.
I don't really care about Q3 or Q4/22 production. I do care about 37,500 boe average production in 2023. It seems like they will catch up to their 2023 forecast from the slow start in Q3 by break-up in 2023.
Much of their Q4 spending is directed at Cardium light oil wells in Pembina and Willesden Green. These are all dialed in production wells. They produce top dollar oil (which is what OBE wants while the WTI - WCS differential is stretched out)
Reflection 7.
37,500 boe average in 2023. $120 WTI. $300 million capex in 2023. 10% share buy back. 50% free cash flow pay out ratio. Zero debt (from the 50% free cash held back). All adds up to about a $4 annual dividend per share starting sometime in the next 12 months (maybe next summer).
How would you feel about a $4 dividend per share?
How much would you pay for a $4 dividend? (a 7% yield is a $57 share price).
I like this reflection a lot. It makes Tuesday and Wednesday's 22% ish haircut feel irrelevant.