Topaz Energy Corp N.TPZ

Great Quarter: Scotia maintains outperform and $35 target

[Westcoastenergy]

Topaz Energy Corp.

• TPZ-T: C$27.02
• Target: C$35.00
• Rating: Sector Outperform

Q3/24 Cash Flows Hit the Mark; Well Positioned for Improving Natural Gas Market Dynamics

OUR TAKE: Positive. TPZ delivered in line Q3/24 cash flows on strong liquids production and ~100% gas processing throughput. The company increased its 2024 royalty production guidance by ~0.4 mboe/d following the close of its latest GORR transaction and remains well positioned to grow both the business and dividend as it moves forward. TPZ’s unique mix of stable midstream revenue and high margin royalty production revenue has been bolstered by strong oil production growth in 2023 and 2024 (~20% CAGR) and is poised to benefit from improving natural gas prices in 2025 and 2026 (~11% CAGR on our forecasts). We believe this unique (and ultra-high margin) revenue mix enables TPZ to comfortably fund its dividend, while leaving the majority of its royalty production open to benefit from improving Western Canadian commodity price dynamics. We continue to see TPZ as the top royalty / income stream name in the sector given its: (1) top-tier free cash flow conversion profile; (2) strong asset base / counterparties; and (3) attractive dividend yield and growth potential.

KEY POINTS

Q3/24 cash flows hit the mark. Production of ~18.7 mboe/d (67% natural gas) was in line with expectations, with liquids production ~4% higher than the Street. Combined revenue of $73.6M was slightly behind consensus expectations, while cash costs of $6.6M came in ~16% better than expected, putting EBITDA, cash flow, and free cash flow (~88% conversion from revenue) in line with the Street. During Q3/24, TPZ realized ~100% utilization from its natural gas processing assets (~242.1 mmcf/d throughput), 216 gross wells (7.9 net) spud (skewed to NE BC Montney and Clearwater), and 176 gross wells placed on production on its royalty acreage. 129 gross wells spud during the quarter were carried into Q3/24, including 76 natural gas wells expected to be placed onstream during Q4/24 and Q1/25. The company spent ~$2.2M on maintenance capex (and capitalized G&A) during the quarter, while ~$5.6M was spent on the Clearwater natural gas gathering project ($24.9M to date). TPZ will fund the final cost of the project (estimated at ~$26M) at completion in late 2024, with annual run rate midstream revenue from the project estimated at $4.3M (subject to adjustments based on the final cost of the project). See Exhibit 1 for detailed results vs. expectations. (Neutral)

2024 guidance update. TPZ updated its 2024 guidance for its recent GORR acquisition (closed on November 4, 2024; see our note for more details). Capex and midstream and other income were reiterated at $4M to $5M and $75.5M to $78M, respectively, while production was increased by ~0.4 mboe/d to 19.1 mboe/d to 20.0 mboe/d (in line with us and the Street at ~19.6 mboe/d) based on 29 to 31 rigs active on its royalty acreage over the balance of the year. The company expects a dividend payout ratio of ~69% and year-end net debt of $460M to $470M (~1.5x EBITDA). TPZ plans to release 2025 guidance in Q1/25 following the public release of 2025 guidance from its key counterparties (Neutral).