Baytex Energy - A Race Against Time

| About: Baytex Energy (BTE)

Summary

Cash flow is not adequate to service long term debt.

The Eagle Ford properties are reporting significantly improved results. But those results may not save the company.

The capital budget has been reduced as management lives within its means. Operational costs are also dropping to offset the budget reduction.

The heavy oil production needs oil prices of $50 per barrel to be competitive with the Eagle Ford. Current oil prices result in breakeven cash flow at best.

Asset sales options will be hampered by the undesirability of the heavy oil assets. The company may have to sell the Eagle Ford assets to pay off the debt.

Baytex Energy Corporation (NYSE:BTE) has a big problem. The heavy oil production is marginal at the current prices and has already been shut down once during the first quarter. Management has estimated that should oil prices head into the thirties, another shutdown is possible. In the meantime, those assets generate some cash flow, but not the cash flow required to justify the investments in the assets for that production. So the debt pile remains with the company unable to really decrease the balance without asset sales.

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Source: Baytex Energy Corporation October, 2016, Corporate Profile

On the other hand, as shown above, the company has some significant operations in the Eagle Ford that have shown considerable cost improvement over the last five years. Management is hoping that the Eagle Ford lease results will enable the company to drill its way out of the current financial situation. The light oil produced by these properties is far more profitable than the heavy oil produced by the Canadian properties so there is a lot of incentive to accelerate development of the Eagle Ford properties at the expense of the heavy oil properties.

(click to enlarge) (Company Reports In Canadian Dollars) Click to enlarge

Source: Baytex Energy Corporation, 2nd Quarter, 2016, Earnings Announcement and Filing

The Eagle Ford production has a higher oil price and lower operating expense that overcomes the extra royalties paid to yield a better operating netback. Clearly management wants to build on that advantage.

Currently the six month cash flow was a little better than C$127 million of which C$81 million occurred in the second quarter. While the second quarter was much better the amount is extremely inadequate to service the C$1.9 billion in long term debt even though there are no maturities for awhile. Much of the progress made in lowering the debt was due to the strengthening of the Canadian dollar because asset sales have so far been pretty minimal. In fact the bank loan balance actually increased about C$90 million in six months. Thank goodness that management does not have to worry about a credit line redetermination for awhile.

"The Board of Directors is pleased to announce the appointment of Trudy M. Curran as a director of Baytex. Ms. Curran holds a Bachelor of Arts degree in English and a Bachelor of Laws degree (both with distinction) from the University of Saskatchewan and the ICD.D designation from the Institute of Corporate Directors. She is a retired businesswoman with extensive experience in executive compensation, mergers and acquisitions, financing and governance."

"If the current commodity price environment continues, or if prices decline further, we may need to make additional changes to our capital program. A sustained low price environment could lead to a default of certain financial covenants, which could impact our ability to borrow under existing credit facilities or obtain new financing. It could also restrict our ability to pay future dividends or sell assets and may result in our debt becoming immediately due and payable. Should our internally generated funds from operations be insufficient to fund the capital expenditures required to maintain operations, we may draw additional funds from our current credit facilities or we may consider seeking additional capital in the form of debt or equity. There is also no certainty that any of the additional sources of capital would be available when required."

These two quotes show the seriousness of the financial position. So management is currently eyeing other financial solutions just in case production improvements do not bail out the company. Investors have been warned even if these moves were not blaring headlines. The company clearly has a tight, but not yet immediately threatening liquidity situation needs to be relaxed.

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Source: Baytex Energy Corporation, October, 2016, Corporate Presentation

The key is the cash flow on the heavy oil and the light oil projects. The heavy oil needs at least $50 per barrel oil prices to be competitive with the Eagle Ford. Yet that oil price level does not appear likely on the current horizon. Those heavy oil projects also have large up-front capital costs. So technology improvements have not been as significant for the heavy oil projects as they have been for the light oil projects. But that could change in the future. So a significant amount of the production has inadequate cash flow and is squeezing the capital budget.

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Source: Baytex Energy Corporation, October, 2016, Corporate Presentation

The two slides above summarize the current situation. Using the "rule of 72", the doubling of the IP rate shown in the first slide translates into about a 14% improvement each year. The 180 day cumulative recovery amount for the Eagle Ford leases obviously lags that by several percent. Given the current cash flow status, the company needs a considerably greater rate of improvement than it has so far attained for the Eagle Ford to produce enough additional cash flow. Ideally cash flow needs to be at least C$600 million a year to adequately service the debt. That is nearly double the latest quarterly rate.

So this company would also need some help from commodity prices. But that help does not appear to be likely. Drilling and other costs are also rapidly decreasing, so there is some operational improvements that will help the cash flow situation. Still, unless the situation changes in the two slides above, this company may not have a long term solution to its financial situation just yet. Therefore investors would be advised to watch this one from the sidelines until the cash flow situation shows significant improvement.

The heavy oil projects will produce cash flow, but not nearly enough. The projections of returns when oil price increase past $50 WTI are probably irrelevant because oil probably will not be there much in the future. As long as the industry continues to report major operational improvements, the chances for a sustained oil price increase dim.

Plus if there were to be significant asset sales, they would most likely be Eagle Ford lease sales. The company would have to be very lucky to sell the heavy oil assets for anything near an adequate amount. The other possibility is that the company adopt a strategy similar to Suncor (NYSE:SU). Suncor has refineries to upgrade the heavy oil production to move profitable products. Whether this company could purchase or merge with a suitable refining partner is probably speculative at best.

The second quarter cash flow of C$81 million points to an annualized cash flow of C$320 million unless commodity prices dive. Eagle Ford operational improvements and cost reductions can maybe improve that cash flow to an annualized rate of $400 million by year end. That is probably too optimistic but a very best case scenario. That includes the hedging program and we might as well assume opportunistic hedging. But at that rate of improvement (an additional C$100 million per year for each of the next two years), the company needs two more years for cash flow to get to C$600 million annually. If commodity prices do not cooperate in that time period, this company could easily go under.

Management is doing the best that it can by using as much of the capital budget as possible to drill wells in the Eagle Ford. But the capital budget has been reduced as the cash flow constrains that budget. Some non-core asset sales will definitely help, but only a part of this company's portfolio is desirable enough to sell. So there is definitely a race against time here with limited upside potential until the financing problems and cash flow challenges are resolved to the market's satisfaction.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

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.