Crew Energy: Slim Margins And High Debt

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About: Crew Energy Inc. (CWEGF), Includes: AETUF, PRMRF
by: Hervé Blandin

Summary

The company will spend the FY 2018 capital program within the cash flow. And management expects the FY production to rise by 4%.

But the high debt and the depressed Canadian gas prices penalize the company.

Management is avoiding the Canadian gas market to improve the netback.

The market values Crew Energy at a discount compared to similar producers due to the high debt and low netback margins.

With the release of the Q3 earnings, Crew Energy (OTCPK:CWEGF) confirms the FY 2018 production growth while keeping the capital program within the funds flow. But due to the low gas price environment, the company operates at slim netback margins and the FY production growth will amount to only 4%.

To improve the netback, management is avoiding the AECO prices by selling the natural gas to several U.S. hubs. The company is also focusing on its liquids-rich assets.

Considering the high net debt, the company has to generate some free cash flow to lower the net debt to adjusted funds flow ratio. And management does not have a lot of flexibility in case the widening WTI/Canadian differential and the low gas prices persist.

The low flowing barrel valuation reflects the difficulties related to the low netback margins and the high debt.

Oil pump jack Image source: skeeze via Pixabay

All the numbers in the article (including slides) are in Canadian dollars unless otherwise noted.

Q3 results

Crew Energy grew its production by 0.4% QoQ and 2% YoY.

Crew Energy Q3 2018 production

Source: Q3 2018 MD&A

By focusing the capital program to the condensate-rich natural gas areas at West Septimus, revenue stayed stable QoQ. But with the liquids prices difference compared to last year, revenue grew by 13%.

Crew Energy Q3 2018 prices

Source: Q3 2018 MD&A

But because of less favorable change in non-cash working capital, the adjusted funds flow dropped to C$20.1 million, representing a 19% decrease YoY.

Crew Energy Q3 2018 adjusted funds flow

Source: Q3 2018 MD&A

And with a capital program of about C$23.7 million during Q3, the company didn't generate any free cash flow.

As a result, the debt increased by C$3.7 million compared to Q2 2018 to reach C$332.9 million.

The table below shows the structure of the net debt.

Crew Energy Q3 2018 net debt

Source: Q3 2018 MD&A

The lower adjusted funds flow and the higher level of debt increased the net debt to adjusted funds flow to 4.1. This ratio is high compared to most of the Canadian oil and gas producers.

But the structure of the debt protects the company against short-term issues. The senior unsecured notes, which represent 88% of the net debt, mature in 2024. And the company drew only C$49.3 million on its C$235 million bank facility.

Avoiding Canadian gas prices

At FY 2018 oil and gas prices, management expects to spend all the C$90 million to C$95 million cash flow to grow the production by about only 4%.

But the company needs some free cash flow to reduce the net debt to adjusted funds flow ratio.

With 75% of gas production, the company is suffering from low gas prices. And the low gas prices will impact the Q4 results as well. During October, AECO (the Canadian gas hub) prices were sometimes negative.

AECO gas prices during October 2018

Source: gasalberta.com

Thus, management is diversifying away from AECO. During Q3, the company was exposed to the AECO prices for 40% of its gas production.

Crew Energy Q3 2018 gas marketing diversification

Source: Q3 2018 MD&A

But the company is turning to different hubs in the U.S to benefit from higher netbacks despite higher transport costs.

Crew Energy Q3 2018 gas marketing diversification in 2019

Source: presentation October 2018

As a result, AECO prices will represent only 5% of the expected revenue in 2019.

The hedging program for the natural gas production matches this strategy. Management hedged the 2019 gas production against the U.S prices only.

Crew Energy Q3 2018 hedges

Source: presentation October 2018

Besides diversifying to the U.S gas markets, the company is focusing its capital program to the condensate-rich natural gas areas at West Septimus.

Valuation

Management confirmed the FY 2018 production goal of 23,500 boe/d to 24,500 boe/d.

For the valuation, I compare Crew Energy with two other Canadian companies operating a similar production mix: Paramount Resources (OTCPK:PRMRF) and Arc Resources (OTCPK:AETUF).

Crew Energy Q3 2018 production mix compared with Paramount Resources and Arc Resources

Source: author, based on company reports

As we can see on the graph above, only Crew energy produces heavy oil compared to a bigger part of oil for the two other producers. NGL and gas production parts are similar. The producers also operate at different scales but it will not impact the costs and valuation comparisons.

The table below compares the netbacks the three producers realized during the last earnings report period (Paramount and Arc did not release the Q3 results yet).

Crew Energy Q3 2018 netbacks compared with Paramount Resources and Arc Resources

Source: author, based on company reports

The recent Paramount's M&A activities disturb some of the data. Thus, I focus on the comparison with Arc Resources. We can see that Crew Energy and Arc Resources operate with similar cash costs and total costs.

But Arc Resources produces more oil and generates higher netbacks. We can also see that the debt penalizes Crew's total cash costs.

The flowing barrel valuations reflect these differences, as shown in the table below.

Crew Energy Q3 2018 flowing barrel valuation

Source: author, based on company reports

Due to lower netbacks and higher net debt to cash flow ratio, the market values Crew Energy at a discount compared with Arc Resources.

The flowing barrel valuation of C$23,166/boe/d is low considering the 25% liquids production and the long-term debt. But the company will have to improve the netbacks in the next few years to generate some free cash flow while growing the production.

The high net debt and the thin netback margins don't provide a lot of flexibility for Crew Energy in case the widening WTI/Canadian prices differential continues. Thus, despite the low valuation, I prefer to stay on the sidelines.

Conclusion

With Q3 earnings, management confirmed that a capital program within the cash flow would grow the production by about 4%. But it also means the company needs to improve the netback to generate some free cash flow while growing.

Also, despite a long-term debt, the company needs higher netbacks to reduce the net debt to adjusted funds flow ratio.

Management is avoiding the depressed AECO prices by selling gas to the U.S. market and by focusing on the liquids-rich areas. But with a high debt and a low netback margin, the company does not have a lot of flexibility in case the recent Canadian liquids prices issues persist.

As a result, the market values Crew Energy at a discount compared to Arc Resources.

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Disclosure: I am/we are long PEYUF, CPG, BTE, BNEFF.

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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