Yangarra Resources Stock Forecast: Pleasant Surprises Lay Ahead For The Rest Of 2021

Summary

• The 2Q2021 results of Yangarra Resources seem to have disappointed the market, with a decline in production, flat funds flow, and slightly higher net debt.
• I analyze the quarterly results to show why the next few quarters will be much better. I point out operational bumpiness is typical for all small-cap producers, including Yangarra.
• The stock seems to be still deeply undervalued despite its low-cost, growth-potent assets run by great management.
• I do much more than just articles at The Natural Resources Hub: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

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Yangarra Resources Ltd. (OTCPK:YGRAF) reported the 2Q2021 results on July 28, 2021. Some in the market were disappointed at the reported results, complaining about the decline in production, flat funds flow, and higher net debt, and sending the share price down to the lower trendline that has been operative since November 2020 (Fig. 1).

Fig. 1. The stock chart of Yangarra, as compared with the WTI benchmark, modified from this source. Buying spree of the educated investors is shown in blue arches, that of FOMO speculators in red arches.

What has happened to the operations at Yangarra? Is the investment thesis of the stock broken? What to do about it?

Below, let's look at the company under the hood.

Operations

Production

Production averaged 8,205 boe/d (liquids 46.1%) during the 2Q2021, a 17% decrease from the same period in 2020 and a 6% decline from the 1Q2021.

• Yangarra drilled and completed 7 wells during the 2Q2021, including a 5-well pad. However, these 7 wells contributed little to the 2Q production. Those 5 wells in the pad were brought on production near the end of June 2021, while the other 2 wells were not brought on-stream until early July 2021.
• Completion of the 5-well pad negatively impacted the 2Q2021 production of adjacent wells. Production was also disrupted by midstream maintenance at the O’Chiese facility, where Yangarra chose not to hire expensive third-party takeaway capacity during the mid-streamers shut down.

With all 7 wells completed, Yangarra was producing ~10,000 boe/d in July 2021. Three wells at O’Chiese and four wells at West Ferrier are scheduled to be drilled and completed in the remainder of the 3Q2021 (Fig. 1). That suggests production may increase to >11,800 boe/d in the 4Q2021 (Fig. 2).

Fig. 1. Yangarra's land position, modified from this source.

Fig. 2. The quarterly average production and liquids percentage of Yangarra, compiled by Laurentian Research for The Natural Resources Hub based on company released information.

The 2Q2021 will probably go down as the low point in quarterly average production. For a small-cap operation running one rig, such bumpiness in average production is to be expected; analysts are supposed to look beyond the quarter-to-quarter variations in production and focus on the longer-term trend in output.

Price realization

Consolidated price realization continued to improve from the 2Q2020 bottom, with the average realized sales price having reached C$38.21/boe, higher than the pre-Covid-19 level as represented by 4Q2019 (Fig. 3).

Fig. 3. The quarterly average sales price realized by Yangarra, in comparison with all-in breakeven and all-in cash costs, compiled by Laurentian Research for The Natural Resources Hub based on company released information.

The following factors contributed to the positive trend in price realization:

• Firstly, the natural gas price has been extremely strong despite the oil crash in early 2020;
• Secondly, the crude oil price has recovered to the pre-Covid-19 levels (Fig. 4);
• Thirdly, thanks to its investment in a fleet of 18 emulsion hauling trucks, Yangarra was able to get the best product pricing (due to blending) and to have the optionality of multiple egress points, wherever a better price can be had.

Fig. 4. The quarterly average prices of crude oil, NGL, and natural gas realized by Yangarra, compiled by Laurentian Research for The Natural Resources Hub based on company-released information.

Revenue

With the lower production offset by better price realization, Yangarra was still able to post increasing revenues since the oil crash in 2Q2020. Commodity prices remaining the same as in the last quarter, revenue in the 3Q2021 will be materially higher than in the 2Q2021 and may rise above that of the pe-Covid 4Q2019 (Fig. 5).

Fig. 5. The quarterly revenue, funds flow from operations (or FFO), cash from operating activities (or CFO), and capital expenditures (or Capex) of Yangarra, compiled by Laurentian Research for The Natural Resources Hub based on company released information.

Costs

It appears the unit cash costs have appreciated since the 2Q2020 (Fig. 6). The primary reason for such an apparent unit cash costs appreciation is the decline in production and resultant loss of economies of scale.

Fig. 6. The quarterly cash cost items of Yangarra, compiled by Laurentian Research for The Natural Resources Hub based on company released information.

• From 4Q2019 to 2Q2021, net debt only increased by 8.0% from C$187.7 million to C$202.7 million but quarterly average production dropped by some 34.7% (Fig. 2).
• Yangarra operates nearly all of its production, thus minimizing the high costs that arise from third-party handling of natural gas production. The unit operating costs have actually dropped from around C$8.98/boe as of 2015 to C$6.74/boe in 2Q2021 in spite of the recent production decline.

It thus follows that the unit cash costs will likely decline as production recovers in the next few quarters so I expect the margins to improve in the near future.

Cash flow

Yangarra pursues vertical integration as the way to drive down structural cost savings and improve capital efficiency. It opened a construction division with the purchase of oilfield/production equipment at depressed prices, so as to save on drilling and completions Capex; its pad cost has now dropped to ~$65,000, down from ~$250,000 when third-party contractors were hired. The Capex that was invested in vertical integration in the last few quarters (Fig. 7) is paying off; the company is positioned for reaping free cash flow down the road as operating cash from operations increases.

Fig. 7. The cash from operating activities, and capital expenditures of Yangarra, from this source.

Yangarra board has approved an increase in capital budget from C$60 million to C$85 million, which means one drilling rig will be fully utilized for the rest of the year. For the second half of 2021, the company is projected to spend C$47 million (Table 1). At that Capex, I expect Yangarra will begin to generate significant free cash flow in the next few quarters.

Table 1. Capital spending of Yangarra, from this source.

Upside and risk

At the current benchmark of US$70 WTI, Yangarra is priced at a forward P/FCF multiple of 1.83X under flat production (10,000 boe/d) and 1.08X under full development. In other words, if commodity prices remain at the current level, and even if it just sustains the current production without pursuing any growth, Yangarra will be able to buy back all shares in merely 22 months (Fig. 8). That is the power of having a forward FCF yield of 55%.

Fig. 8. The projected FCF profile of Yangarra in the scenarios of flat production and full development, from the same source as Fig. 8. The flat production scenario assumes 10,000 boe/d, while full development assumes 24 wells in 2021 and 24 wells per year thereafter, resulting in exit production of 9,550 boe/d for 2020; ~14,500 boe/d for 2021; ~17,000 boe/d for 2022; ~19,000 boe/d for 2023; ~20,500 boe/d for 2024; and ~22,000 boe/d for 2025. The base-case commodity prices are US$65 WTI, US$5.00 differential, 1.20 forex, C$72 Edmonton Par, and C$3/gj AECO. The operating costs are to be kept at C$6.50/boe, G&A at C$0.50-.55/boe, and interest expense at C$2.15/boe. The base oil decline in year 1 is 55% and 50% thereafter, while the base natural gas decline in year 1 is 38% and 35% thereafter.

Relative to its NAV estimates and the current share price, Yangarra is deeply undervalued. The end-2020 reserves were based on a price deck that is below the current strip prices.

• Going forward, the share price has plenty of tailwinds. Since 2018-2019, Yangarra has further reduced well drilling and completion costs to ~C$3.25 million per two-mile well, which will result in lower future development capital for 2P reserve additions, thus making future reserve additions more economic.
• Historically, as the oil cycle swings higher, the valuations of oil stocks shift from the PDP value, via the 1P value, to the 2P value. Yangarra has an enormous upside to look forward to (Fig. 9).

Fig. 9. The NAV per share in terms of the PDP/PNP, 1P, and 2P reserves, as compared with the share price, from this source.

Apart from the subsurface uncertainties, some of the main risk factors associated with Yangarra are as follows:

• As for uncertainties in the commodity prices, Yangarra currently hedges ~50% of crude oil production, ~25% of NGL production, and ~20% of natural gas production, which exposes the company to upside as well as downside in the spot market.
• Yangarra carries a lot of debt, with the adjusted net debt to 2Q2021 run-rate FFO ratio at 2.94X. The company intends to reduce debt to C$150 million, however, deleveraging will compete with production growth for the capital.
• With a steep decline curve, its growth outlook will depend on access to capital. As of June 30, 2021, Yangarra has C$210 million credit facilities. The amount available under these facilities is redetermined at least twice a year, primarily based on Yangarra’s oil and gas reserves and lender's forecast commodity prices. Of the C$210 million credit facility, Yangarra has drawn C$199.474 as of June 30, 2021. Between the undrawn credit facility and the steadily improving cash flow, Yangarra seems to have adequate liquidity to fund the operations.
• Going forward, I anticipate little equity dilution. The last equity raise - for C$11.5 million - was done back in 2016. In the six quarters from 3Q2019 to 2Q2021, the basic share count increased by 0.3%, while the fully-diluted number of shares expanded by 3.7%. The personal interest of the management and board appears to be well aligned with that of the retail shareholders, judging from the 25.6% fully-diluted insider ownership.

Investor takeaways

Yangarra boasts low-cost assets and a technically capable and shareholder-friendly management team, as I previously discussed. At the current share price, the stock is still a deep value relative to the forecast FCF and intrinsic value; it thus offers a risk-reward profile extremely advantageous for investors. Yangarra meets all the value investing criteria as I laid out here.

I have shown above that the market's negative reaction to the 2Q2021 results as reported by Yangarra might be excessive in the sense that insufficient consideration was given to the prospect of significant operational and financial improvements in the next few quarters.

Therefore, I believe discerning investors who are open to investing in high-quality, small-cap ideas should consider going long Yangarra at this time.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of YGRAF either through stock ownership, options, or other derivatives. 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.