Enerplus Will Have To Pull Itself Together In 2016 And Start Hoarding Cash

| About: Enerplus Corporation (ERF)

Summary

Enerplus was able to do some 'damage control' in Q4 to protect its balance sheet.

The capex has been slashed once again to just 40% of the FY 2015 level.

This will have consequences, and the average daily output will fall by 10,000 barrels per day.

Enerplus should generate a sufficient amount of cash to survive until at least 2019 without being forced to sell more assets.

The dividend cut is a good step, but I think it should be reset at zero for the time being.

Introduction

In a previous article, I was wondering if Enerplus' (NYSE:ERF) death spiral was warranted. Yes, the entire oil and gas sector is in a terribly bad shape, but Enerplus remains a major producer and had a very favorable debt repayment schedule. The company has to repay just US$150M before the end of this decade, so Enerplus is definitely in a position to wait for a better oil and gas price and doesn't urgently need a refinancing, unlike other oil and gas companies. The share price has now increased by 20% since my article, and I'll try to find out if there's more to come.

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Q4 was okay on the operational front

The average production rate in the fourth quarter was almost 107,000 boe/day resulting in a small guidance beat (of 1%), and a 3% output increase compared to the production results in 2014. That's a pretty good result and Enerplus definitely deserves a pat on the back as it was able to achieve a slightly higher production rate despite having cut the capex guidance by 39% and selling assets with a total production rate of 6,000 barrels per day.

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Source: financial statements

So, yes, Enerplus had a very good quarter in terms of production, but the main question obviously is how much cash the company has been able to generate.

Source: financial statements

The full-year revenue came in at C$1.03B ($746M) but due to some very hefty impairment and depletion charges, Enerplus' pre-tax income actually was a net loss of C$1.7B ($1.23B) and even after some minor income tax recoveries, the net loss remained quite substantial at C$1.52B ($1.11B). Of course, this net loss was predominantly caused by the non-cash charges, and I think the majority (if not, all) of the fast-growing oil and gas companies will have to reduce the fair value of their assets. However, this doesn't have an influence on the cash flow profile, and I was hoping to see Enerplus generating a decent amount of operating cash flow as well.

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Source: financial statements

Unfortunately the company hasn't provided a cash flow statement for the fourth quarter of this year, so I had to do some calculations by myself. The full-year operating cash flow was C$465M ($337M) but this did include a net gain on the value of its derivative instruments (read: the oil and gas hedges) of C$143M ($104M), so the unhedged operating cash flow in FY 2015 was approximately C$320M ($233M).

After dissecting the Q3 financials, it looks like the unhedged operating cash flow in 9M 2015 was approximately C$276M ($200M) which means Enerplus' adjusted operating cash flow in the final quarter of the year was approximately C$50M ($36M), give or take a few millions.

Another dividend and capex cut probably is the best way to deal with this

The total operating cash flow of C$465M ($337M) wasn't sufficient to cover the full-year capex of approximately half a billion Canadian Dollar, but fortunately Enerplus also sold some properties for roughly US$210M which covered a large part of that bill as well.

In the previous article I also already discussed the company was planning to slash its capital expenditures but has now decided to reduce the total capex even further. Whereas Enerplus wanted to spend C$350M on capital expenditures, it has now revised this number to just C$200M. That's a saving of C$150M but this obviously also has consequences for the company's production profile. Every oil and gas company has to deal with decline rates and if a company doesn't invest a sufficient amount of cash in its properties, the production rate will start to slide.

It's very often a very difficult balancing exercise between spending cash on the properties and the output, and Enerplus will see its average production rate fall by 10% to 90-94,000 barrels of oil-equivalent per day, which will have a negative impact on the operating cash flow as well. That being said, the weak Canadian Dollar and some hedges for FY 2016 will very likely allow the company to break even in 2016 (excluding the income from hedges), and be free cash flow positive once you include the cash inflow from the hedged positions. Enerplus has hedged in excess of 50% of its Q1 oil output at US$60 per barrel, and 34% of its Q2 output at a slightly higher price.

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Source: company presentation

The cash inflow from unwinding these hedging positions will very likely result in Enerplus be free cash flow positive and this should allow the company to increase its cash position to have some sort of financial buffer to repay the US$90M in debt that is due in 2017 and 2018.

I wasn't happy to see the company was still paying a dividend and even though Enerplus has now announced it's cutting the dividend by an additional 67% to C$0.01/share/month from April on, it's still one cent too much. Yes, the net outflow has been reduced by US$36M per year, but let's face it, it makes no sense to still pay an annualized US$18M in dividends when you have a net debt position of US$885M.

Investment thesis

Enerplus is choosing a lower production rate to save more cash, and I don't think that's a bad move as it doesn't make a lot of sense to keep the production rate high at a time you're selling a part of your production at either a loss or very low operating margin. The dividend cut is another good move, but I think suspending the entire dividend would have been an even more prudent move.

Enerplus is very lucky it doesn't have to repay any substantial amount of debt before the end of this decade, and this will be the company's saving grace. Yes, oil can stay low for a bit longer, but I would expect the oil (and gas) price to increase again by 2018/2019 which should allow Enerplus to generate more cash flow to repay its debt, or at least make it easier to refinance (a part of) its debt.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.