March 10, 2023
Headwater Exploration Inc.
Q4/22 - Solid Exploration Results
Our view: Q4/22 results were largely in-line with management outlining a successful exploration campaign in multiple areas, which we expect will be well-received. The company also provided a favourable reserve update in our view, with material increases in each category, strong recycle ratios, and a generally conservative book. We expect Headwater will continue to be active on delineation, providing potential drilling catalysts through the balance of the year.
Key points:
Q4/22 generally in-line. Q4/22 volumes of 15,546 boe/d were in-line with RBC/consensus estimates of 15,682/15,920 boe/d. CFPS of $0.31 compared to RBC/consensus at $0.29/$0.29; see exhibit 1 for key variances and estimate changes. Q4/22 E&D capital spend of $63 million (RBC/ consensus: $59/$60 million) factored in 27 net wells in Marten Hills and 3 exploration wells in West Nipisi.
Solid exploration results across multiple areas. Headwater outlined a successful exploration campaign, spanning West Marten Hills to Peavine/ Seal with several results well above type curve. We expect continued momentum on this front will be well-received. The company continues to aggregate land, adding 31.5 net sections at West Nipisi, and plans to test out a fishbone well design in the second half; see Exhibit 1 for more details.
Material increase to 2022 reserve book. Headwater provided its 2022 reserves, which exhibited a 69%/35%/44% increase in PDP/1P/2P reserves, largely attributable to ongoing delineation activity to further prove up the asset base. Waterflood reserves also increased to 5.7 mmbbl, up from 0.7 mmbbl previously, driven by continued momentum on the core block. PDP reserves now account for 79%/48% of 1P/2P reserves. Additionally, 2P FDC increased 69% y/y with 2P FDC/2023E Capex mapping to 0.8x; see Exhibit 2 for additional details.
Solid balance sheet supports exploration, RoC. Headwater announced its $0.40/sh annual dividend with Q3/22 results (note here), now yielding roughly 6.3%. We estimate the dividend is covered down to just under US $60/bbl, with management noting dividend growth will likely be aligned with growth in the underlying business. Based on our updated estimates, we forecast Headwater to carry roughly $50/$89 million in net cash at year- end 2023E/24E ($4/($108) million at strip), providing plenty of optionality to accelerate development and/or enhance shareholder returns.
Reiterating Sector Perform rating. We reiterate our Sector Perform rating and $8.00/share price target. Headwater shares trade at roughly a full- turn premium to oil-weighted peers (Exhibits 4/5), which we believe is justified given pure-play Clearwater exposure, a competitive dividend yield, and management's track record of value creation. However, the current valuation appropriately captures these factors, in our view.