Tourmaline Oil: Attractive Valuation

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About: Tourmaline Oil Corp. (TRMLF), Includes: AETUF, BIREF
by: Hervé Blandin
Summary

Tourmaline Oil released excellent Q1 results and announced a strong dividend increase.

I expect lower netbacks over the next few quarters.

The valuation offers a margin of safety even with lower realized prices.

Tourmaline Oil (OTCPK:TRMLF) released strong Q1 results. The company is still operating at lower costs compared to some other similar producers. Thanks to its low costs and higher realized prices, cash flow increased compared to last year.

As planned, the company grew production, reduced debt, and paid a dividend. And, in contrast with many Canadian producers that struggle to reduce net debt, management even announced a 20% dividend raise.

But, taking into account the evolution of oil and gas prices over the last several weeks, I expect the company to generate lower netbacks over the next few quarters.

Yet, considering the low valuation, the stock price still offers an interesting upside potential even with lower short-term results.

Tourmaline Oil production areas

Image source: Tourmaline Oil

Note: All the numbers in the article are in Canadian dollars unless otherwise noted.

Excellent Q1 Results

Tourmaline is on its way to exceed the symbolic production threshold of 300,000 boe/d. During Q1, production increased 9% year-over-year and reached 293,434 boe/d.

Tourmaline Oil Q1 earnings: production mix

Source: Q1 2019 MD&A

The 21% growth in NGL production is due to the development of the Gundy area in northeast British Columbia.

Thanks to its gas marketing diversification and higher oil prices compared to the year before, the company realized a higher price of C$25.15/boe.

Tourmaline Oil Q1 earnings: realized prices

Source: Q1 2019 MD&A

Compared to some other Canadian producers operating a similar production mix, Tourmaline's costs stay low.

Tourmaline Oil Q1 earnings: costs and netbacks

Source: Author, based on company reports

The table highlights Tourmaline's lower total cash costs. Also, before hedges, Tourmaline realized a higher total netback. Birchcliff (OTCPK:BIREF) realized a similar total netback thanks to hedges and a temporary situation I described in this article.

Tourmaline Oil Q1 earnings: production mix compared to Birchcliff and Arc Resources

Source: Author, based on company reports

With better prices, higher production, and low costs, cash flow increased from C$352.2 million to C$419.2 million. And with cash flow above the growth Q1 capex of C$384.4 million, the company slightly reduced the net debt to C$1.718 billion and paid the C$27.2 million dividend.

The net debt is still low with a net debt to TTM cash flow ratio at 1.0x.

Considering these excellent results, management announced a 20% dividend increase starting in Q2. But I expect the context to be less favorable over the next few quarters.

Lower realized prices for the rest of the year

Despite the strong increase in NGL production during Q1, gas production still represented 82% of the total production. And gas revenue after hedges represented 70% of the total revenue.

For the rest of the year, gas production will be exposed to the prices listed as per the graph below.Tourmaline Oil gas hedges in Q2-Q4 2019

Source: Presentation June 2019

Management hedged 20% of gas production. The rest is exposed to Canadian (39%) and U.S. (41%) prices.

Considering the usual lower Canadian gas prices during summer and the limited hedges, I expect the company to realize much lower prices over the next two quarters. The futures AECO pricing shown below confirms the lower gas prices during spring and summer.

AECO futures gas prices

Source: Gasalberta.com

Also, due to the prolonged low gas prices, the company hedged a part of its gas production at C$1.55/mcfe only.

Tourmaline Oil Q1 earnings: gas hedges

Source: Q1 2019 MD&A

Since the beginning of the year, U.S. gas prices have been declining as well. As shown in the graph below, the Henry Hub prices even dropped below US$2.50/mmbtu over the last few weeks.

U.S NYMEX gas prices

Source: Marketsinsider.com (prices in US$)

For the rest of the year, Henry Hub futures don't indicate a strong recovery with prices staying in the range of US$2.313/mmbtu to US$2.662/mmbtu.

U.S. NYMEX gas futures

Source: Cmegroup.com (prices in US$)

The company confirmed its 2019 production goal and forecasted a cash flow of C$1.5 billion.Tourmaline Oil Q1 earnings: guidance 2019

Source: Presentation June 2019

But the expected cash flow and free cash flow assume the following prices during 2019:

  • Natural gas: NYMEX at US$3.00/mmbtu and AECO at C$1.80/mcf.
  • Oil: US$60.00/bbl.

Compared to the gas prices I listed above and the hedges, these assumptions seem optimistic. The oil price forecast of US$60/bbl isn't conservative either. As shown below, since the beginning of the year, WTI price averaged US$57.78/bbl and WTI spot price is now below US$55/bbl.

Oil prices in 2019

Source: psac.ca

Thus, for the rest of the year, I don't expect the company to realize prices and total netback as high as during Q1.

Valuation offers a margin of safety anyway

Over the last few weeks, Tourmaline's stock price erased its gains accumulated since January, 1. In contrast, the Canadian Crude Index increased by almost 32%. But, since the beginning of the year, Tourmaline overperformed compared to Birchcliff Energy and Arc Resources (OTCPK:AETUF).

Chart Data by YCharts

Tourmaline's stock price still represents an interesting opportunity, though.

From the flowing barrel perspective, the market values the three producers in a tight range of C$20,818/boe/d to C$23,866/boe/d. Tourmaline's small discount to Arc Resources seems attractive as Tourmaline generated a higher total netback during Q1. But Arc Resources has greater exposure to oil prices.

Tourmaline Oil Q1 earnings: flowing barrel valuation compared to Birchcliff and Arc Resources

Source: Author, based on company reports

The valuation of 2P reserves confirms Tourmaline's discount compared to Arc Resources.

Tourmaline Oil Q1 earnings: reserves valuations compared to Birchcliff and Arc Resources

Source: Author, based on company reports

The market values Birchcliff's reserves at an important discount to the two other producers. The lower valuation reflects Birchcliff's expected lower total netbacks. Also, Birchcliff's large reserves favor a low valuation. The net present value of barrels that will be produced in more than two decades is worth less than the value of barrels produced today.

Coming back to Tourmaline, let's assess its intrinsic valuation. If we assume the company will generate a total netback of C$8/boe over the long term, as it did over the last two quarters, I estimate the fair value of the stock price at C$35.95.

Tourmaline Oil Q1 earnings: intrinsic valuation

Source: Author

The valuation assumes a 12x multiple to the profits the company would generate while holding production flat.

The current stock price offers a 52.77% discount to my fair value estimate.

Assuming the free cash flow of C$876 million that corresponds to a total netback of C$8/boe, the market values the company at a free cash flow yield of C$876 million / (C$16.98 * 299,371,410 shares) = 17.5%.

This valuation is close to the 20% free cash flow yield opportunities I wrote about over the last several weeks (here and here).

But I discussed I expect lower realized prices over the next few quarters, which will impact the total netbacks. The table below shows the company needs to realize a total netback of C$3.8/boe to justify the current stock price.

Tourmaline Oil Q1 earnings: intrinsic valuation with pessimistic assumtpions

Source: Author

Thus, even if the company realizes lower prices for the rest of 2019, the stock price still offers a comfortable margin of safety. The company only needs to realize prices above C$3.8/boe to represent an upside potential.

Also, the debt ratios are low. In contrast with many Canadian producers, Tourmaline isn't under pressure to reduce its net debt.

Conclusion

Tourmaline reported strong Q1 earnings. As planned, the company is growing its production and will soon exceed 300,000 boe/d. In the meantime, the free cash flow after growth capex supports debt reduction and the dividend.

Assuming the same realized prices as during Q1 over the long term, the market values the company at an important discount. But, over the short term, I expect lower realized prices and lower netbacks.

Yet, the current valuation still offers some upside potential even with reduced profits. Also, the company isn't under pressure to reduce its net debt.

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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.