Cardinal Energy: Safest Yield In The Canadian Energy Sector
Summary
- Cardinal pays a 7.7% yield that is fully covered at US$55 WTI.
- Current share price is a result of lack of investor interest in Canadian energy sector but sentiment could turn very quickly.
- We remain bullish on Cardinal due to the highly appealing yield and torque to higher oil price and narrowing WCS discount.
Cardinal Energy (OTCPK:CRLFF) will report its second quarter in early August and we thought it would be helpful to review Q1 and discuss several upcoming catalysts for the stock. We have been long Cardinal and have a cost base of around C$4.77. The stock suffered a major re-rating when it announced the light oil acquisition, an unfortunately timed acquisition. The market was very difficult in late 2016 and any company announcing acquisition was punished by the market. Cardinal has not been able to recover its lost ground despite several other Canadian O&G companies delivering superior returns, such as Gear (OTCQX:GENGF), Athabasca (OTCPK:ATHOF), and MEG (OTCPK:MEGEF). However, the aforementioned names were all high beta names with high torque to oil prices. Cardinal represents another opportunity that offers a highly attractive 7.7% yield which is fully covered at current strip pricing and has a wide margin of error as long as WTI stays above US$55. We continue to view Cardinal as a core holding for energy investors looking for safe yields.
In the last quarter (2018 Q1), Cardinal continued to deliver a strong quarter despite heavy WCS discount. The heavy oil discount has improved dramatically since Q1 and we expect Q2 to shape up to be a much stronger quarter from a cash flow and earnings perspective.
Production continues to shift towards light oil and Cardinal pursues its strategy of diversifying away from medium oil. We believe Cardinal's goal of providing modest production growth within cash flow is prudent and is supported by its industry-leading decline rate.
Netback has significantly improved from the same quarter last year due to higher WTI pricing and improved operating costs. The light oil acquisition has contributed to improved the netback
Bank debt increased during Q2 2017 but has since been consistently repaid by Cardinal through free cash flow generation. To us, this is one of the most important positive signs for investors as management is clearly focused on managing leverage through solid execution.
To recap our investment thesis, it is crucial to view Cardinal under various pricing scenarios. Based on our estimates, Cardinal is able to maintain a best-in-class dividend payout ratio as long as WTI stays above US$55-$60. If oil prices recover to higher levels, Cardinal will be able to comfortably raise its dividends after it had to cut its dividends by half in January 2016.
Upcoming Catalysts
We think there are two major catalysts for Cardinal in the coming quarters. The first catalyst is the narrowing WCS discount. For a detailed discussion of the WCS discount, see "Canadian Heavy Crude Discount Demystified". Despite the discount blowing through US$30 during Q1, it has been reduced to US$17 recently due to increased rail capacity and positive news from Enbridge (ENB) Line 3 approval and the purchase of Kinder Morgan (KMI)'s Trans Mountain Expansion project by the Canadian government. We expect the discount to remain between US$15-$20 for the remainder of 2018 and approach US$15 as Line 3 gets built and put into service. Based on WTI US$65, the table below shows sensitivity based on various WCS discounts. For every US$5 improvement in discount, Cardinal's cash flow would improve by almost C$30 million. We view the current environment as highly constructive for Canadian producers as new pipelines will improve pricing in the near future.
The second catalyst is the announcement of the final royalty sale. Cardinal announced the second royalty sale in March for $26 million following the first sale in October 2017 for $14.5 million. We eagerly await further royalty sale and expect any deleveraging event to be positive for the shares. Cardinal has no leverage issues and has ample liquidity. However, the company incurred a large amount of bank debt as part of the 2017 light oil acquisition. There have been management changes (CFO retired) and the company has missed its previous goal of completing four royalty sales by the end of 2017.
In summary, the Cardinal story remains intact as the company continues to pay down bank debt through free cash flow generation while funding its fully covered dividends. Any royalty sale would incrementally benefit for the stock and we see the continued narrowing of WCS as a tailwind for Cardinal.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
Analyst’s 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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Comments (10)
www.jwnenergy.com/...
Improved pipeline prospects snarl rail talks: Cenovus CEO
www.jwnenergy.com/... The outlook for any O&G producer in Canada looks bleak... Canada is their own worst enemy.. and I ownGXOCF OBE CPG
