Cardinal Energy: Deep Value With An Ignored Near-Term Catalyst

About: Cardinal Energy Ltd. (CRLFF)
by: Volte-Face Investments

Typically, one has to sleuth about deep in the weeds to figure out catalysts in a value situation or be prepared to wait it out for unknown time for market recognition.

The Canadian energy market is so loathed and abandoned nobody is listening even to the public statements.

Cardinal has likely told the public about a massive dividend increase in a month and the market ignores it.

(All dollar amounts herein are in Canadian Dollars)

The recent collapse of Canadian energy companies has been spectacular. It came from December's breakdown of the ability of Canadian oil companies to ship oil to export markets (leading to the government stepping in and actually legally curtailing production to match export capabilities). This has left this sector a (brave) value hunters paradise. Seeing a sector in this kind of trouble for many value stock-pickers is like lighting off the Bat Signal on the clouds above Gotham City for Batman (I drive a hybrid so I do arrive slower).

Seeing this opportunity, I prepared to do the typical investigations and begin what is, in my experience investing in energy small caps, a time-consuming process. Typically there is a lot of detective work that usually has gone into my winners (sadly also my losers too). Not just getting the 10-Q or reading the management power points but teasing meaning out of maps of drill sites, third-party articles about equipment moving, finding industry articles that contain a loose hint about one company's potential or activities, even getting articles in foreign language local newspapers translated, etc.

But Cardinal Energy's (OTC:CRLFF) current predicament is very different than that. Cardinal has in my opinion flat out told you in April of this year they will be raising the dividend materially. No hiring private eyes here. Just reading the public statements. So let us see what the current situation is and where it might be going.

Cardinal is a low decline oil producer currently running with a roughly half the Enterprise Value of its billion dollars NPV in reserves. Even better for a dividend model oil company, they really are low decline too...

(From this September 2018 corporate presentation back when life was good and the corporate presentation wasn't under construction)

But what might a jaded, oil sector-burned investor say? He or she might tell you the investing world is littered with stocks selling for less than they are worth for years. This can especially be the case with low liquidity small caps with modest analyst interest in secondary markets (nothing personal Canada). In such a situation, this condition can persist for years before something happens.

Needless to say, this is an objection I have a great deal of respect for.

The first part of my investment thesis here is that this company pays a dividend. The dividend is a critical way to get shareholder cash out of a business that probably can't grow in the near term and has been affected by a sentiment collapse. It's a lot easier to wait in a value stock if you get paid to sit there. Indeed at its close of this writing, that dividend is 5.5% or 12 cents a month on a $2.10 price. This dividend was obliterated in early December. It dropped from 3.5 cents a month to just 1 cent a month. This was when many producers of Canadian oil were receiving (due to pipeline congestion and grotesque political incompetence in Canada dealing with pipeline buildouts) around half the prevailing price for oil a similar US producer might receive just 100 miles south across the border. This issue has been addressed at the provincial level with a heavy-handed program to buy train cars to ship oil, several regulatory moves to free pipeline space that was being used inefficiently, and even restrict producers from producing any more than "fits" in the export systems that exist. Even smaller Cardinal has had to shut-in a small amount of its production to comply. But the effect on oil prices has been significant.

Here are three prices to show what I mean (these prices in US Dollars).

Canadian Crude Index (mix of blends) prices on three select dates

October 1, 2018 - $38.94 per barrel

November 26, 2018 - $21.13 per barrel

March 8th, 2019 - $42.70 per barrel

So just from these three prices, one can see just how low the crash dip was for these oil producers. Cardinal Energy had thought that the dividend was safe and that was their model. But they failed to protect the dividend with hedges (and they could have hedged it wonderfully for most of the summer of 2018, so this is a pretty material failure). So to protect the balance sheet the dividend was slashed to the bone. As a sop to brutally burned investors, they did state in their dividend communications when they cut that this would be temporary, and based on oil prices, they would re-evaluate the dividend in April 2019 when the board met.

Okay, our pessimistic friend might say, I get what you're going for here Volte-Face. This is a "hope for a restoration of the dividend play". But that's just hope and I don't want to be stuck in a two dollar oil stock with a 5% dividend waiting for management to decide to raise it.

Well, Mr. Pessimist, let's get more information. We can look in Cardinal's operating budget statement released on Feb. 28th of 2019 in which they state:

  • Forecasting debt repayment of 10% to 15% of total debt by year-end
  • As oil prices stabilize, dividend level to be re-evaluated in April 2019.

Well we can see from the last quarter they have approximately 230 million in outright long term debt (3rd Q 2018) but I will use a 250 million dollar number (I'm using approximations since it's possible that debt rose in the bottom of the 4th quarter pricing disaster, I don't know - we don't have the 4Q yet) to make it a safer way to calculate and give room.

So we know what they are trying to do with their remaining adjusted funds flow from this year, target debt repayment and do something with the dividend. What is their net funds flow estimation (again from the same release)?

The base capital program results in adjusted funds flow net of development capital expenditures of approximately $43 to $53 million to fund dividend payments and for debt repayment. Cardinal's total payout ratio, which is represented by the capital program plus dividend payments divided by adjusted funds flow is expected to be 65%. As production growth is expected to be limited by the Alberta oil curtailment program, production is forecasted to average 20,400 to 20,800 boe/d for 2019.

Now, this statement includes all of the negative issues above, all the problems and issues that have come through the Canadian oil space recently. But for some time now, both Canadian oil and gas have been trading above the budget and their respective spreads to benchmarks have been better than laid out in the Feb 28th release.

Therefore, I think I can outline the following scenario pretty reasonably.

Start with the midpoint of the adjust funds flow estimate so...

48 million dollars

Set aside out of the AFFO a sizable amount to aim at hitting a reduction of 10% of the debt (10% of 250 million in my estimation) so...

25 million dollars

Cost of Current dividend annualized at 1 cent a share a month which Cardinal just told us in 2019 will cost...

15 mm dollars

Total for current dividend and material debt reduction by the company in 2019 (remember this company is low decline and has a proved and probable reserve life of 15 years right now with limited drilling).

40 million dollars of AFFO required.

This means in this modest scenario there are around 8 million dollars to raise the dividend, something the company seems to want to do since they are in whatever is worse than the doghouse since they shattered the shareholder base in December with the 3.5 a cent to 1 cent drop. If they apply that 8 mm for the remaining dividends starting with the May 2019 dividend, a 1.75 cent a month dividend fits nicely into the mix (around 6 million dollars for the year leaving money for general safety). This would also fit nicely into a narrative as it would be a return to 50% of the previous dividend. A 1.75 cent a month dividend would also represent a current yield of 10% as of this writing and given the stock's horrible performance I see no evidence any good news is priced into this stock.

Now there are a tremendous number of moving parts in this calculation (like the next 9 months oil prices for example) and anyone with any sense will realize it will not be possible to pin these down 9 months in advance to perfect specificity. Nonetheless, the potential outlined here is very clear given the sheer size of the cash flow set aside for debt repayment above. If something needs to be moved around, there would still be a huge amount of cash flow for debt payment, even if it's "only" say twenty million dollars on an annual basis.


This is a speculative scenario based on my own estimates and public company statements. I could insert an endless list of disclaimers here. Let's summarize them by saying, none of this has to happen. The company could simply elect to be hysterically conservative and remain at 1 cent. Our previously mentioned pessimist would not be out of line to say "Well Volte, you said they've publicly stated it and you are still guessing".

All. True.

But in my analysis, the company has repeatedly stated publicly the dividend cut is temporary and will be revisited. They've publicly used a specific date repeatedly. They've finally started a proper hedging program (maybe a little early, but they've done it). They've laid out in public a fairly conservative CapEx budget with no idiotic "growth for growth's sake" and shown the adjusted funds flow from that. Even with the 1.75 cent a month dividend I am speculating they will go to, they will be able to pay down around 25 million in debt, leaving them tremendous flexibility and giving any dividend proper coverage and safety (okay Mr. Pessimistic, I it as much safety as is practical for $2 speculative Canadian oil stocks offer).

Oil prices are volatile, but the provincial government of Alberta seems very serious about keeping the various spreads to benchmarks from breaking its economy. Even if oil remains flat from here and AECO gas flattens out to its 12-month curve, Cardinal should be coming in at the high side of its fund flow estimates leaving even more room. Even if they miss the self-reported debt reduction target by some percentage, they'd still be paying a fabulous dividend in my scenario and simultaneously paying down debt respectably every month. If I am wrong and April comes with no dividend raise, then you'd own a company paying an adequate near 6% yield that will be paying down something stupendous like 15 to 20% of its debt annually from cash flow. This is not exactly a disaster scenario.

Given this setup and the short time to April 2019 where we will know if I am right or wrong explains why I have gone long this stock.

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.

Additional disclosure: I have no plans to transact on any other security mentioned in this article over the next 72 hours. This article is not a solicitation to participate in any of Volte-Face's strategies. All the information included in this article was believed by the author to be accurate at the time of publication but is not guaranteed. This is not investment advice but is a description of the author's thoughts or an explanation of his actions.