Yangarra Resources In 2020

Summary

• Yangarra released mixed third-quarter results.
• Management communicated its 2020 capital program.
• The upside potential remains significant.

With its third-quarter results, the Canadian oil and gas producer Yangarra Resources (OTCPK:YGRAF) announced its 2020 capital program. Despite mixed results during this quarter, the valuation of the company based on its next-year plan remains attractive.

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

Mixed third-quarter results

Last quarter, Yangarra had announced the goal of drilling five to six wells and complete four to five wells during its third quarter. But the results fell short of expectations since the company drilled only three wells and completed five.

In its third-quarter press release, management provided the following short explanation that points to temporary issues:

As a result of issues with a third-party contractor, production adds in the third quarter were delayed and capital costs were higher than expected.

Thus, production decreased to 12,724 barrels or equivalent a day (boe/d), down 2% quarter over quarter. But thanks to its capital program over the last several quarters, Yangarra increased its production by 23% compared to last year.

Source: Press release Q3 2019

Liquids decreased to 46.2% of the company's total production compared to 47.2% during the previous quarter. The lower-than-expected number of new wells during this quarter explains the drop in liquids production since the company's new wells bring an extra amount of liquids during their first months of production.

Source: Investor presentation November 2019

As I mentioned in my previous article, I expect Yangarra's liquids production to match its reserves' liquids proportion of 44% to 46% over the long term.

Since management didn't update its production guidance range of 13,000 boe/d to 14,000 boe/d, the disappointing third-quarter production will require a strong increase in next-quarter production to match management's guidance. For instance, fourth-quarter production will have to exceed 14,278 boe/d, which corresponds to a quarter-over-quarter increase of 12.2%, to match the low end of management's guidance of 13,000 boe/d.

This may be the reason management announced a 2019 capital program of C$110 million instead of the initially planned C$100 million. And since the forecasted annual adjusted funds flow is still in the range of C$95 million to C$105 million, the company will now generate a negative free cash flow of about C$10 million in 2019.

Also, during the third quarter, the company's net debt increased to C$185.8 million because of its capital program of C$26.6 million above its adjusted funds flow of C$19.1 million.

As a result of its higher net debt and lower adjusted funds flow, the company's net debt to adjusted annualized funds flow ratio increase to 2.4.

You should consider a couple of elements, though. The company purchased C$3.2 million of land at "compelling valuations", according to management's statement, which increased the capital program. And the lower oil and gas prices during this quarter had a negative impact on adjusted funds flow.

Source: Press release Q3 2019

The increased C$110 million capital program for this year implies the fourth-quarter capital program will amount to approximately C$16 million, which would correspond to positive free cash flow assuming stable oil and gas prices compared to the third quarter.

As a result, net debt should come closer to C$180 million by the end of this year, and the net debt to 2019 adjusted funds flow ratio should drop below 2.

Yangarra in 2020

Besides the increase in the company's 2019 capital program, management also revealed its 2020 plans. With a capital program of C$120 million, Yangarra should drill 30 wells and production should increase in the range of 14,000 boe/d to 15,000 boe/d.

Assuming Edmonton Par prices (Canadian hub for oil) of C$66.6/bbl and AECO gas prices of C$2.00/GJ, management expects adjusted funds flow will match its C$120 million capital program in 2020.

With management's price assumptions, net debt should stay stable in 2020. And with a net debt at about C$180 million at the end of this year, the net debt to adjusted funds flow ratio would drop to 1.5 by the end of 2020.

Also, the company's market capitalization of C$101.4 million at a share price of C$1.18 corresponds to 0.845 times the forecasted 2020 adjusted funds flow. Given the company's reasonable debt and its profitability, its valuation seems extremely low.

With depressed gas and NGL prices during this third quarter, the company still realized a total netback (profit per barrel, all costs included, assuming flat production) of C$5.75/boe before favorable hedges.

Source: Author, based on company reports

The company doesn't communicate its sustaining capital. But in a previous article, I explained I used the company's PDP FD&A costs of C$10.15/boe as a proxy for its sustaining costs.

However, these costs are likely to change. The extra C$10 million for the 2019 capital program corresponds to an increase in sustaining costs. On the other hand, the acquisition of land at "compelling valuations" should lower these costs, depending on the reserves associated with these lands. Since we have no extra information till the release of the next reserves report in a few months, I still consider C$10.15/boe of sustaining costs, keeping in mind these uncertainties.

Assuming stable third-quarter realized prices and costs, total netbacks will stay at C$5.75/boe. With the midpoint of the 2020 production guidance of 14,500/boe/d, Yangarra will realize a profit of C$5.75/boe * 14,500 boe/d * 365 days = C$30.4 million assuming it holds its production flat.

The current valuation corresponds to a free cash flow yield of C$30.4 million / C$101.4 million = 30%.

With this context, management announced the implementation of a share buyback program without giving any detail about the timeframe and the size of the authorization. Often, these programs cover 5% to 10% of the companies' shares over one year. At a share price of C$1.18, management can buyback 10% of the company's 85.9 million diluted shares with only about C$10.1 million.

Yangarra has the potential to execute such a program since its credit facility limit has been confirmed at C$225 million and its net debt should stabilize at about C$180 million assuming no free cash flow in 2020. Besides, increasing net debt to C$190 million will imply a still reasonable net debt to annualized adjusted funds flow ratio of 1.6 at the end of 2020.

Conclusion

Despite its mixed third-quarter results, Yangarra is still an attractive oil and gas producer. The company generated positive total netbacks close to C$6/boe despite depressed NGL and gas prices. Also, it will grow its production while reducing its debt ratios with its 2020 capital program of C$120 million at reasonable oil and gas price assumptions. And with a market capitalization close to C$100 million, the stock price upside potential remains significant.

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Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long YGRAF. 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.