November 4, 2022
Headwater Exploration Inc.
Downgrading to Sector Perform
Our view: Q3 results were in line with expectations and featured strong exploration results around the core Marten Hills area. We believe the initiation of a RoC policy was widely expected (and likely priced in) but will be well-received, though a softer medium-term outlook could weigh on the stock near-term. We have reduced our estimates to reflect management's updated guidance and downgrade the stock to Sector Perform.
Key points:
Q3/22 broadly in line with expectations. Q3 volumes of 11,612 boe/d were in line with/slightly below RBC/consensus estimates of 11,652/11,820 boe/ d. Accordingly, CFPS of $0.25 was in line with RBC/consensus at $0.25/ $0.25; see exhibit 1 for key variances and estimate changes. Capital spend totalled $71 million (RBC/consensus: $70/$67 million) which included 9 exploration wells at Marten Hills West and 8 injection wells on the core block.
Exploration updates. Headwater continues to de-risk the greater Marten Hills area with strong results across the region as noted in Exhibits 1 and 3. At Shadow, the company is currently drilling its first strat well and will follow this up with the first multi-lateral imminently. The company will drill three horizontals in the area before drilling one well in Peavine, Utikuma, and Seal through the first quarter of 2023.
2023 outlook softer than anticipated. Management maintained its 2022 production guidance of 13,000 boe/d (exit 16,000+ boe/d) and increased capital to $245 million (previously $230 million) on the back of inflation and pre-spend for 2023. Management also released a preliminary 2023 outlook with capital of $200 million driving average production volumes of 18,000 boe/d. This is below RBC/consensus at 19,500/19,100 boe/d on similar capital of $225/$205 million. We have reduced our production and CFPS estimates by 7%/15% and 5%/12% in 2023E/24E.
Cash flow sustainability, balance sheet strength backstop RoC strategy. Headwater announced a $0.10/share quarterly dividend, mapping to a yield of roughly 5.4%. Management anticipates this is sustainable down to US$55/bbl and expects it to grow alongside the broader business. We currently forecast $188/$249 million in net cash on the balance sheet in 2023E/2024E (we forecast most peers will also reach a net cash balance by year-end 2023).
Downgrading to Sector Perform. We downgrade Headwater shares to Sector Perform given what we view as a full valuation following strong performance in recent weeks. Headwater shares trade at a large 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, we believe the current valuation appropriately captures these factors.