Enerplus: The Recent Weakness Is Unjustified

Summary

• ERF is a monthly dividend payer with a strong balance sheet.
• The company managed a very nice turnaround since 2015.
• The recent weakness in the share price offers a nice opportunity.

In my first article on an O&G name, I analyze Enerplus Corporation (NYSE:ERF). The company was established 1986 and is currently traded on the Toronto Stock Exchange and NYSE. This North American energy producer with operations in Western Canada and the U.S. is a monthly dividend payer, yielding c. 1% annually.

From the historical perspective, the company has been fairly profitable until 2015, when the prices of oil plummeted to their historical lows and the company's revenues fell some 42% compared to 2014. By the end of 2015, the company had also accumulated more than C$1 billion in debt. Since then, however, the company managed to turn things around and the recent weakness in the share price nudged me to sit down and have a closer look-if only because I am quite interested in turnaround stories and this seems to be a good one to look at.

*2018 includes only revenues for 9M2018

Source: Author based on Macrotrends and company data

So what happened in 2015?

As I have briefly discussed earlier, the oil prices fell from their highs in 2013 and 2014 to c. $35 per barrel in 2015 and continued to fall to as low as $27 per barrel in 2016. A more detailed chart is provided below. Due to the depressed prices, the company not only had lower revenues but had to test its assets for impairment as well which led to an impairment charge of C$ 1,352.4 million.

Data by YCharts

This was, however, not the only problem the company faced. The company accumulated more than C$ 1 billion in debt and because of a continuously small cash position, the net debt had remained above C$ 1 billion from 2012 until 2015. This all led to the share price touching the $2.3 level in January 2016.

Since that time, the share price has advanced to c. $13.5 and subsequently decreased today's $8.8-$9.0 levels. Below, I argue why the recent share price weakness might be still be a good opportunity.

The story of the turnaround

ERF is a monthly dividend payer and in order for the company to be able to cope with its debt load, the dividends had to be decreased to the current $0.0073 a month (or c. 1% annualized yield). In 2016, ERF disposed of assets within its non-core divestment program for proceeds of C$670 million which helped to significantly reduce the net debt. Through a placement of new shares, ERF also increased its cash position by C$220 million.

The enhanced cash position was then used for repayment and repurchase of debt. ERF repurchased US$267 million of outstanding senior notes and managed to do so at a discount, which resulted in a gain of C$19 million. As result of the these steps, the long term debt decreased from C$1.2 billion as of 2015-end to C$739 million as of 2016-end. Furthermore, the oil prices picked up and as they had been growing over the course of 2016, the company was showing other good signs as well. Good management and tight cost control resulted in the operating costs per BOE decreasing some 17% year on year, for example.

Source: Author based on company data

These positive signs did not end with 2016 and the company continued to improve to the present. Revenues grew 27% in 2017 compared to 2016, with costs increasing only 15% year on year. 2017 EBT margin increased as well, by 11 percentage points year on year and the net income margin decreased only because of the tax benefit recognized in 2016.

Tight differentials are also driving the margin expansion as shown on the chart below available in the company's December 2018 presentation. The difference between ERF's natural gas price and NYMEX shows a similar development.

Source: ERF's December 2018 presentation

In terms of production, ERF's average daily production numbers have been decreasing since they peaked in 2015, mostly due to the company's non-core divestment program.

Source: Author based on company data

If one looks at the core assets of the company, however, the numbers look a bit more promising as the company's assets located in the Williston Basin (North Dakota and Montana) exhibit a robust light oil production growth. ERF sees a 20% CAGR of the light oil production of its core assets between 2016 and 2019. Furthermore, the assets in Sleeping Giant, Montana are characterized by low capital expenditures and strong cash flow generation. Quarterly production data show ERF hit the upper end of the guidance for the fourth quarter of 2018 as it produced, on average, 97.8k boe/day. For 2019, the company sees its production averaging between 94k-100k boe/day.

Source: ERF's December 2018 presentation

Source: Author based on company data

The balance sheet position further improved in the first 9 months of 2018, compared to the end of 2017. The chart below presents ERF's repayment schedule. In none of the years until 2026 the company has to repay more than C$130 million. The senior notes are the only outstanding debt the company has and with ERF's ability to generate cash from its operations, the repayment schedule is not that risky (depending on the oil prices, of course).

Source: ERF's December 2018 presentation

The ability of the company to generate cash from its operations is obviously derived from the oil prices. I am always careful with commodity prices and admit I can hardly forecast them. This brings me to the recent slip in the company's share price which I attribute to two different reasons-one, the overall weakness in the stock markets and two, the recent slip in the oil prices. The spot price of WTI Oil has already started to recover from the $45 level at the end of the last year to c. $51, and the oil price might continue in its upward trend as long as the OPEC+ countries are committed to rebalancing the market.

So while the oil prices are rising, on the P/BV and P/E (Forward) multiple, the company's valuation has slid and has not yet fully recovered. Furthermore, ERF's P/BV multiple is now below the company's 3-year median.

Data by YCharts

Data by YCharts

Conclusion

The company managed a nice turnaround and the growth of the stock price which bottomed at $2.3 per share in 2016 is justified. However, the recent weakness in the share price offers a nice opportunity as the quality of the company has not deteriorated but valuation remains quite low. The investment thesis is the following-ERF is cheap, it is a monthly dividend payer with a strong balance sheet, experiencing a margin expansion on the back of both increasing oil prices as well as cost control, production is growing, and the recent weakness of the stock price which is not justified given the company's fundamentals.

Analyst’s 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.