Equal Energy (EQU) delivered its second quarter results on August 9th. The company results were negatively impacted by the decade low NGL and Natural Gas prices in the second quarter. However, despite the weak pricing and cash flow impact investors in the company have many reasons to be optimistic.
Higher Production - Lower Capital Spending
Equal Energy delivered strong production at 10,349 barrels per day (50.3% liquids) presenting a 9% increase over last year's production level of 9,060 barrels per day. As a result of the company's strong production performance management raised 2012 production estimates to 9,800 bpd -10,200 bpd from 9,500 bpd to 9,800 bpd projected earlier in the year; this accomplishment is even more meaningful considering that management cut projected capital spending by around 20% in order to limit spending to within cash flow.
Confirmation of the Cardium Sweet Spot
Last month I published an article detailing Equal Energy's sweet spot in the Cardium and the expected strong production from this acreage upon the application of the slick water fracturing technique; this observation was confirmed subsequent to the quarter with the company drilling its best well to date at the Lochend Cardium. From the earnings press release:
One Cardium horizontal oil well was drilled in the second quarter. It was completed subsequent to the end of the quarter and tested 890 barrels of oil per day over an initial 9 day period and is currently shut-in for a pressure build up and testing. This appears to be one of our strongest Cardium wells to date and will be placed on production by the middle of August. A second Cardium well has been drilled with the completion expected by the middle of August with first production by the end of August.
This well performed as good as the recent wells drilled by the largest operator in the Lochend Cardium -Pengrowth Energy (PGH). From Pengrowth's August 10th quarterly earning press release:
two (0.95 net) wells were brought on stream in the Lochend area with a combined 30 day IP rate of 800 boepd.
Pengrowth Energy indicated that the Lochend Cardium remains one of their core capital spending areas for 2012, and it does appear that this area continues to deliver the best returns for the company.
Mississippian Marching On
Equal Energy drilled its first Mississippian well with its partner Atlas Resource Partners (ARP) on June 17th, a second well is being drilled currently and a total of at least six wells are planned for 2012. According to Atlas, the first Mississippian well is projected to be put in production in September. The Mississippian production will significantly increase Equal Energy's oil production in the Unites States, which is mostly composed of Natural Gas and NGLs; unlike the company's Canadian production which is 82% light oil.
Strategic Review on track
In consideration of shareholders demands Equal undertook a strategic review on May 3rd in collaboration with Scotia Waterous. On August 9th Equal Energy disclosed that its board of directors has received multiple proposals as a result of the review:
As of the date of this report, the strategic review has resulted in a number of proposals being delivered to the Company.
Equal did not disclose the nature of the proposals, however it is understood that during the strategic review process prospective buyers expressed interest in the uniformity of the company asset base. It is highly likely that Equal received a variety of proposals concerning its Canadian assets portfolio, its US assets portfolio and for the company as a whole. The company's management has expressed its intention to conclude the review in a timely and proper manner, thus investors should expect the review to conclude in the not too distant future.
The rational for the strategic review continues to be very relevant as the company continues to trade at a significant discount to its peers:
(click to enlarge)
Source : TD Waterhouse
Equal best compares to the "No Yield" group, follows are some of the metrics pertaining to Equal Energy:
2012 EV/BOEPD: $26000
2012 EV/DACF: 5.0
2012 % Gas: 50%
EV/P1BOE: $7.51
EV/P2BOE: $6.86
Most recently, the Hunton/Mississippian operator Eagle Energy LLC was acquired by Midstates Petroleum (MPO) for $650m at a valuation of $50.19 per barrel (PDP) and $92800 per flowing barrel. While Eagle has a much larger focus on the Mississippian, the valuation discrepancy of 80% discount per flowing barrel and 85% discount per barrel for Equal Hunton/Mississippian assets is extreme.
New Trust IPO
During the shareholder activism process, shareholders have advocated for the company to divest its Canadian light oil portfolio and convert its US Hunton/Mississippian asset base into a mutual fund trust. This new model has gotten a new boost recently after the introduction of a third such trust in the Canadian market - Argent Energy Trust .
The valuations metrics at which Argent came public bodes very well for a future Equal Energy Trust. In the following table, I will compare a future Equal Energy Trust with Argent Energy Trust and another such trust - Parallel Energy Trust.
Equal Energy Trust* | Parallel Energy Trust | Argent Energy Trust | |
PDP Reserves | 22.63m (45% liquids) | 31.96m (63% liquids) | 1.845m (15.3% liquids) |
PDP + PUD Reserves | 30.71m | 45.1m | 6.9m |
PDP RLI | 6.9 years | 12.5 years | 2.66 years |
PDP + PUD RLI | 9.35 years | 17.69 years | 9.95 years |
Production | 9000 bpd | 7000 bpd | 1900 bpd |
Production composition | 3% Oil, 43% NGLs, 54% NG | 65% NGLs, 35% NG | 1.8% NGLs, 20.2% Oil, 78% NG |
Production cost per BOE | $6.32 | $7.01 | $4.38 |
Valuations: | |||
Per flowing barrel | $19,400 | $85,500 | $98,000 |
Per PDP barrel | $7.73 | $16.7 | $101 |
Per PDP+PUD barrel | $5.69 | $11.83 | $27.1 |
Net Debt | -$65m | -$190m | +$36m |
EV/DACF (2012) | 4.3 | 11.1 | 8.5 |
D/DACF (2012) | 1.62 | 4.7 | N/A |
Dividend | 40c to 80c** | 96c | $1.05 |
* Equal Energy Trust assumes a divesture of Equal Energy Canadian assets portfolio for $85m, which is the midpoint estimate by Desjardins Securities issued on May 4th.
** The final dividend amount will depend on the company capital spending plans in the Hunton and the Mississippian, shares buyback post divesture, the introduction of a DRIP plan and expectations for commodity prices.
As can be seen from the above, an Equal Energy Trust would compare favourably to existing trusts. As a matter of fact, an Equal Trust appears superior on a number of metrics to both Argent and Parallel. Armed with a better valuations and low debt load an Equal trust can pursue further growth in the US through continued Mississippian drilling, which would introduce a growing oil production component in addition to paying a growing dividend as the NGL bottleneck at Conway is addressed, thus significantly increasing cash flow in 2013.
It is worth noting that Equal Energy is the sole Canadian E&P that has the option of converting to a dividend paying mutual fund trust (after the Canadian divesture) since current regulations allow this model only for Canadian companies with assets in foreign jurisdictions.
Equal Energy presents a very attractive investment opportunity at current levels: the company is performing exceptionally well operationally; meanwhile the strategic review provides a clear and approaching catalyst that could unlock significant value - either through an outright buyout of the company or through a restructuring to a dividend paying trust.
Disclosure: I am long EQU.
