Tamarack Valley: A Safe Dividend And More
Summary
- The Canadian oil and gas producer doubled its production volume thanks to several acquisitions since last year.
- At current commodity prices, the company will be generating strong free cash flow to quickly deleverage.
- It initiated a dividend that remains sustainable at low oil prices, and shareholders' returns are poised to significantly grow in 2022.
imaginima/E+ via Getty Images
Given the strong recovery in oil and gas prices over the last several months, Tamarack Valley Energy (OTCPK:TNEYF) initiated a monthly dividend that corresponds to a dividend yield of 2.77% as of this writing.
Interestingly, if commodity prices remain at current levels, shareholders should expect significant additional returns as soon as 2022. Let's see why.
A transformed oil and gas producer
Since mid-2020, Tamarack Valley transformed its production profile through multiple acquisitions listed below.
Source: Presentation October 2021
In total, the company spent C$743 million via cash and stock to roughly double its production volume. It produced 41,256 barrels or equivalent per day (boe/d) during the third quarter, up from 21,253 boe/d in the prior-year period.
Also, the company increased its exposure to oil prices with oil and NGL production at 71% of the total production volume during the last quarter compared to 59% last year.
Source: MD&A Q3 2021
As a consequence, the company's net debt jumped from C$219 million at the end of 2020 to C$520 million at the end of the last quarter.
Source: MD&A Q3 2021
But given the surge in commodity prices and the increased production volumes, adjusted funds flow exceeded C$102 million during the third quarter, up from C$31 million in the prior-year quarter. And without C$24 million of unfavorable hedges, adjusted funds flow would have reached C$126 million.
Thus, overall, the company's net debt-to-annualized funds flow ratio has become reasonable at 1.3, down from 1.9 at the end of 2020.
What's more, thanks to the low-cost structure of its assets, Tamarack Valley can sustain its production at an average WTI price of approximately US$33/bbl, well below WTI prices currently above US$80/bbl.
New monthly dividend
Given the company's quick deleveraging thanks to high commodity prices and strong operating performance following its acquisitions, management announced a new capital framework that includes the payment of a monthly dividend commencing in January 2022.
At Tamarack Valley's current share price of C$3.6, the monthly dividend of C$0.0083 represents an annual yield of 2.77%.
Room for more returns to shareholders
Management will detail its comprehensive budget in January 2022, but shareholders should reasonably anticipate extra returns as soon as next year, assuming commodity prices remain constant.
Indeed, the monthly dividend corresponds to an annual cash outflow of C$40.5 million. That's only 10% of the third quarter annualized adjusted funds flow of C$410 million, which includes C$94 million of annualized unfavorable hedges.
Also, management announced a preliminary plan to spend C$200 million to C$225 million in 2022 (to be confirmed in January). Extrapolating Q3 results and conservatively assuming flat production (management hinted at modest organic production growth), free funds flow should come close to C$300 million next year.
Of course, those estimates depend on many moving parts (price differentials, production performance, costs, hedges, and more), but the point is that the newly announced dividend should represent only approximately 13% of next-year free funds flow, which will give ample room to further reduce the net debt by at least C$250 million next year.
And taking into account extra free funds flow by the end of this year, the company should reach its long-term debt target of C$250 million to C$300 million during 2022.
Interestingly, management announced that, when net debt drops to that C$250 million to C$300 million range, it will increase returns to shareholders from 25% of free funds flow to 50% via special dividends and/or share buybacks.
Source: Presentation October 2021
That means that returns to shareholders can increase to C$150 million as soon as next year, which would more than triple the C$40 million cash outflow the newly announced base dividend represents.
Risks
Of course, the company remains exposed to the risk of low commodity prices. As a reminder, infrastructure constraints resulted in negative Canadian AECO spot gas prices in 2018. And last year, WTI prices also briefly reached negative territory because of the coronavirus pandemic.
However, thanks to its low-cost structure, the company offers downside protection. The current production and dividend remain sustainable at WTI prices of $US35/bbl. And despite the company's low-cost operations and shrinking debt, management stays prudent by using hedges to protect cash flows.
Source: Presentation October 2021
Potential acquisitions represent another risk, as management will be considering additional transactions. Tamarack Valley's recent acquisitions showed management's ability to take advantage of modest valuations. But investors should watch the company's next moves won't lead to overpriced acquisitions going forward in the context of much stronger commodity prices.
A stock for dividend investors
In any case, several Canadian oil and gas producers remain attractively priced despite the surge in oil and gas prices over the last several months. For instance, I explained in July I bought more shares of Crescent Point Energy (CPG) shares because of the stock's significant free-cash-flow yield.
Tamarack Valley is no exception. Despite its share price surging by more than 300% since last year, it still represents an attractive investment to consider for dividend-oriented investors.
Assuming C$300 million of free funds flow next year, the stock represents an attractive free-funds-flow yield of 20% with a safe dividend as long as WTI prices stay above US$35/bbl. And if current commodity prices hold, the upside potential for extra returns to shareholders will become significant.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CPG 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.