Cardinal Energy: Organic Production Growth In 2017 Supporting The 5% Dividend Yield

| About: Cardinal Energy (CRLFF)


Cardinal Energy reduced its activities to 'maintenance mode' in 2015 and 2016.

Now the oil price has settled above $50/barrel, the company will increase its production rate by 10-15% in 2017.

A smaller 1,000 boe/day bolt-on acquisition will be completed on favorable terms.

At $55 oil, the operating cash flow will be sufficient to fund both the capital expenditures and the 5% dividend yield.


Cardinal Energy (OTC:CRLFF) has been one of my favorite oil-related investments (NYSEARCA:OIL) as the company is producing light oil (which means it gets a more favorable price than the heavy oil producers) in the 'right' areas of Canada. This allows the company to keep its production costs at just US$15/barrel and even during severe downturns, Cardinal Energy has been able to keep its cash flows under control.

Now that the oil price seems to be holding its ground above $50/barrel, Cardinal Energy is now planning to 'get back in the field' and complete new wells, which should result in (organic!) production growth. On top of that, Cardinal announced a small bolt-on acquisition, which I consider to be a good and smart move.

CJ Chart

CJ data by YCharts

Trading in CRLFF on the OTC market is quite light, so I would strongly recommend you to trade in Cardinal's shares through the facilities of the Toronto Stock Exchange, where the company is trading with CJ as its ticker symbol. The average daily volume in Canada is in excess of 300,000 shares per day.

A small bolt-on acquisition at favorable terms!

Cardinal Energy is always looking for interesting acquisitions (at the right price), and the company has entered into an agreement to purchase assets located in the North Mitsue area where Cardinal Energy already has an operating base.

Source: Company presentation

The company is paying C$41M (US$30M) for light oil assets that are pumping 1,000 barrels of oil-equivalent per day, and have approximately 3.4 million barrels in the proved plus probable reserve basis. This means Cardinal has purchased the assets for C$12.05 per barrel (US$9), and at a price tag of US$30,000 per flowing barrel.

This seems to be relatively cheap (especially knowing 90% of the purchase price has been paid in Cardinal shares - although a straight cash payment could have been better in case the oil price increases again), but I made a small comparison how the acquisition terms relate to the company's year-end ratios.

I used the average production rate of 14,600 barrels per day in 2016 and the Q3 2016 net debt as base case, whilst I used the Proved and Probable reserve base as disclosed by the company earlier in 2016, assuming the reserves have remained stable throughout the year (with exploration results offsetting the depletion of the existing wells). All results are in Canadian Dollars, to avoid any rounding errors.

Metric Notes
CJ value per flowing barrel C$46,232 EV of C$675M, 14,600 boe/day
Acquisition per flowing barrel C$41,000 1,000 boe/day
New average (C$/flowing barrel) $45,897
CJ P+P value per barrel C$11.34 EV of $675M, 59.5M barrels in P+P
Acquisition cost per barrel C$12.09
New Average C$11.37

As you can see, Cardinal Resources purchased the producing asset at a price approximately 10% lower than the ratio it's trading at. It's paying a bit more for the 2P reserves, but I'm confident Cardinal will be able to identify additional reserves on that land package.

All in all, this seems to be a good acquisition at a very fair valuation.

Cardinal Energy will fund its drill program and dividend with its own cash flow

The acquisition isn't the only way how Cardinal plans to increase its production rate, and Cardinal will now hit the ground running in 2017. Whereas the company was preserving cash in 2015/2016 and just did some basic maintenance capex to keep its production levels stable, it's now ready to increase its production rate again.

Source: Company presentation

Cardinal has designed a C$59M capex plan which will include C$16M for facilities and pipelines whilst C$32.7M will be spent on drilling 18 new wells (16.2 net to Cardinal Energy). This should allow the company to increase its production rate to 16,800-17,300 boe/day, and puts us in a position to calculate the capital efficiency of the company.

Source: Company presentation

After all, we now know the 2016 year-end production rate (approximately 15,600 boe/day), the guidance for 2017 (17,000 boe/day, rounded) and the total capex related to drilling wells (C$33M). We also know the natural decline rate of the company's assets (15%, although this will likely increase in 2017), which means the production would decline by 2,400 barrels should Cardinal drill no new wells.

This means the drill bit will have to increase the production rate by 4,000 boe/day (2,400 natural decline rate + 1,400 boe/day production growth), and at a capital intensity of less than C$10,000 per flowing barrel (US$7,500/boe), Cardinal Energy has one of the highest efficiency ratios of the entire sector which allows it to increase its production rate at a very moderate cost.

Investment thesis

Cardinal Energy expects to generate a net operating cash flow of C$92M based on US$55 oil, C$3/mcf AECO and a CAD/USD exchange rate of 0.74. This means that on top of the total capex budget of C$55-60M, the dividend will be fully covered (3.5 loonie-cents per month, for C$33M per year). That's a comfortable situation to be in, and we have very little doubt that should the oil price approach the $60/barrel, Cardinal Energy will borrow more cash to expedite its drill program.

The dividend seems to be quite 'holy' for Cardinal Energy, but just to give you an idea about how much 'damage' the company would do if it would spend its entire operating cash flow on capex and drilling, the C$33M that will be spent on the dividend would allow Cardinal to increase its production rate by an additional 3,000 boe/day, and would push the daily output to in excess of 20,000 boe/day. I personally would prefer the company to drill more new wells, but I do understand Cardinal Energy wants to keep its dividend-focused investors happy.

With a small bolt-on acquisition at a very fair price and near-term production growth, Cardinal Energy is still very high on my list, and I have added more shares on the current pullback. The current dividend yield is approximately 5%, whilst the free cash flow (OpCF - sustaining capex) at US$55 oil is approximately C$0.80 (US$0.60) per share.

Disclosure: I am/we are long CRLFF.

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.

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