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Why Three Analysts Believe This Natural Gas Small Cap Is Undervalued

Streetwise Reports, Streetwise Reports
0 Comments| May 27, 2020

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The firm's project in Brazil has a contract price that is twice the natural gas price in the U.S.

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Alvopetro Energy Ltd.'s (ALV:TSX.V; ALVOF:OTCQX) Caburé natural gas discovery in Brazil is ready to come online and the firm just amended its long-term sales agreement with Bahiagás, the distributor for the state of Bahia, to double its Firm deliveries.

Bahiagás, which is extending the pipeline 15 kilometers and constructing a new City Gate—gas receiving station—has agreed to increase its natural gas deliveries from Alvopetro to 300,000 cubic meters per day (10.6 million cubic feet per day), reduce any potential supply failure penalties through 2020, and prepay Alvopetro for 120,000 cubic meters a day for the months of May and June, a figure roughly equivalent to US$1.1 million. Alvopetro agreed to provide a 15% discount on the prepaid natural gas in May and June.

"Once the Caburé field is on production we expect ALV to generate significant free cash flow to fund an extensive drilling program in 2021." - Bill Newman, Mackie Research

Based on a floor price of US$5.20/million BTU (mmbtu), Alvopetro expects gross revenues in 2020 to total US$11.3 million, and expects EBITDA of approximately US$7.5 million for the second half of the year.

These actions were favorably viewed by analysts covering the company. Analyst Bill Newman of Mackie Research wrote on May 15, "We view these amendments as positive and we maintain our SPECULATIVE BUY recommendation and our $1.65 target price." Alvopetro shares are currently trading at around CA$0.80/share.

Hannam&Partners research analyst Anish Kapadia wrote on May 15, the "Gas Sales Agreement amendment provides further security and reduces risk even further." Concerning Alvopetro's contracted price of US$5.20/mmbtu, Kapadia stated, "to put this price in context, global spot gas prices are currently trading at or below US$2/mmbtu. From August to December, ALV will likely receive the floor pricing in the contract, which remains a very attractive US$5.2/mmbtu, generating an operating netback of >US$4/mmbtu." The firm calculates a risked net asset value of C$1.67/share, "which includes the value for development upside, potential tolling revenues and one exploration prospect. We estimate that Alvopetro is trading on 2x EV/EBITDA in 2021, with a ~30% FCF [free cash flow] yield."

Trickle Research senior analyst and managing partner David L. Lavigne wrote on May 25, ". . .we think Alvopetro has arrived. In retrospect, management has delivered on the project and that should translate into growing cashflow and better corresponding valuations. . .As a result of the recent milestones, we are establishing a new (higher) 12-24 month price target of $1.25 per share."

Alvopetro has been developing the Caburé gas field for several years, when it discovered that the deposit crossed a block boundary. "In Brazil, when that happens, you unitize the discovery with your neighbor, which we completed in April 2018," Alvopetro CEO Corey Ruttan told Streetwise Reports. "Almost in parallel, we signed a gas sales agreement with Bahiagás to monetize the natural gas. As opposed to an oil project, where you basically bring the well on production and take it to a refinery, for a gas project, the lead times are much longer: you have to identify a market, build the infrastructure to connect your discovery to the market and then you sell the gas."

The company has built a gas processing facility; Bahiagás is extending its pipeline and constructing the City Gate at Alvopetro's physical plant to transport the gas from the field to the market, and expects to complete construction in June. "We'll be starting production from our share of the unitized field at the end of this quarter," Ruttan said.

"This project is really the first of its kind in Brazil," Ruttan explained. "No independent company has built a gas processing facility and signed a gas sales agreement with a local state distribution company, to my knowledge. We're leading the charge in Brazil on its initiatives to open up and expand the natural gas market in Brazil. So there's certainly a lot of support for the project at the government and regulatory levels."

The contract with Bahiagás blends three different international benchmark commodity prices to calculate the price of the natural gas: Brent oil, Henry Hub natural gas and the UK NBP, national balancing point gas price. "The contract has a floor and a ceiling, that insulates us from massive price shocks. Our price is much higher than what we are seeing in North America right now. Even at our floor pricing, which is just over US$5.20 per MMBTU, that's roughly 2.5 times what producers in the United States are getting." Ruttan said.

As far as doubling the firm delivery volume, Ruttan explained that when the contract was set up, "we had partly firm deliveries and partly flexible or interruptible volumes. Given that our price is more attractive for consumers than Petrobas', our assertion was being able to deliver flexible volumes was a beneficial thing for us. Now with the pandemic, there has been a lot of demand destruction, hopefully just on a temporary basis, but we thought it prudent to lock in those volumes and make sure our supply has a firm commitment associated with it. The revised contract also allows us to significantly reduce our potential supply failure penalties, so we can do that on a relatively low risk basis."

The amended agreement provides a guaranteed level of revenue. "When you combine that with the floor pricing, it allows us to be free cash flow positive at a time when most companies are shutting in production, realizing massive reductions in their share prices, and are looking at being free cash flow negative," Ruttan said. "I think we're uniquely positioned. At these production volumes, we can basically keep a flat production profile for 8 to 10 years with virtually no maintenance capital."

In addition, there is room for Alvopetro to expand. "There's a lot of excess capacity in that City Gate so that we can we can grow our business," Ruttan said. "Our business plan is, step one, get first cash flow from this discovery, and that will get us close to 11 million cubic feet per day. The plant capacity that we have built is for 18 million cubic feet a day, so our second step will be to ramp that production up toward 18 million cubic feet a day because we can do that at virtually no incremental cost. It's basically fixed costs for us so that next 7 million cubic feet per day is quite profitable."

Bahiagás City Gate has a capacity of handling 70 million cubic feet a day. "We'd like to capture as much of that as possible and it would be relatively straightforward for us to double the size of our processing facility," Ruttan said. "So we'd like to build the business into 36 million cubic feet a day as a medium- to longer-term step."

Next up is an early-stage gas project, Gomo, that Alvopetro is working to prove up. "We have an inventory of exploration prospects. In our current portfolio we've got eight conventional prospects, mostly gas weighted," Ruttan said.

"This is the only independently owned facility capable of delivering sales specified natural gas. We think there's a lot of opportunities here from a business development perspective," Ruttan concluded.

Mackie analyst Bill Newman notes that Alvopetro will be "self-funding once Caburé is on stream. ALV has reprocessed over 1,200 km2 of 3D seismic and has a current inventory of 8 conventional oil and natural gas exploration prospects. Once the Caburé field is on production we expect ALV to generate significant free cash flow to fund an extensive drilling program in 2021."

Trickle Research's David Lavigne stated on May 25, "...there is the potential for additional increases to Caburé reserves as well as perhaps the delineation of Gomo reserves and/or others that may emerge. Each of those opportunities could result in added reserves and associated value. Moreover, as we covered in the initial research, we believe the completed infrastructure could lead to additional midstream opportunities for Alvopetro as well. To translate, we expect other opportunities, perhaps on various fronts, to emerge as we move forward. In our opinion, those and other emerging opportunities coupled with management's now proven ability to accomplish what they set out to do could provide a basis for additional valuation legs for the stock price."

Alvopetro has approximately 88.4 million shares outstanding, and officers and directors own a little over 8%.

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