Gran Tierra Energy: Expected Free Cash Flow Implies A Higher Stock Price
- Gran Tierra Energy Inc. runs oil and gas exploration and production business with assets in Colombia and Ecuador.
- Management believes that the company’s CFO will be sufficient to finance the development of the 2022 capital program.
- In my view, accountants will likely recalculate the reserves. The total amount of assets per share may increase.
Gran Tierra Energy (NYSE:GTE) reports a significant amount of proven oil reserves. Also, the company recently received a good amount of debt financing to finance future development of GTE's oil production. I also appreciate that management will be able to finance its 2022 capital expenditures with its own cash flow from operations. Besides, I don't believe that the current share price successfully represents the future FCF. Under my own DCF model, the shares are worth much more than the current stock price. I am a buyer.
Gran Tierra Energy: 2022 Capital Program To Be Fully Funded By CFO
Gran Tierra Energy Inc. runs oil and gas exploration and production business with assets in Colombia and Ecuador. I would like to go straight to the point. The company's most valuable assets are located in Colombia, where the company expects to use $160-$170 million in development in 2022. The company does run exploration projects in Ecuador, but investors will most likely appreciate assets under a development stage:
There is another outstanding feature about Gran Tierra Energy. Interestingly, management believes that the company's CFO will be sufficient to finance the development of the 2022 capital program. We are talking about a business that generates sufficient cash flow to finance its own capital expenditures.
We expect our 2022 capital program to be fully funded by cash flows from operations. Funding this program from cash flow from operations relies in part on Brent oil prices being at least $60 per bbl for 2022. Source: 10-k
I also appreciate the numbers delivered about the company's proved reserves. As of December 31, 2021, the amount of proved reserves was equal to 66 MBOE. I believe that this figure will most likely increase in the near future because the company used a price of $68/bbl. After the invasion of Ukraine, the oil price increased to a higher mark, so the assets are worth much more. In my view, once accountants will recalculate the reserves, the total amount of assets per share may increase, which may lead to an increase in the share price:
As of December 31, 2021, Gran Tierra Energy Inc. reported a healthy balance sheet. With $26 million in cash and an asset/liability ratio of more than 1x, in my view, most investors will not be worried about the company's financial situation. With that, note that more than 80% of the total amount of assets are represented by proven oil and gas properties. Hence, the company needs financing to develop its oil and gas properties. Without more financing, management will not be able to report consistent free cash flow:
In the last report, management reported $587 million in debt, which is not a small amount. I believe that we should do careful due diligence on the company's financial debt:
The list of contractual obligations reveals that the company financed its operations with 6.25% senior notes and 7.75% senior notes. A significant portion of the company's debt will be payable from 2025, so until then I wouldn't be worried about the company's financing obligations:
Valuation Under My Own DCF Model
For my DCF model, I assumed a beta of 2, cost of debt of 9.2%, and cost of equity of 11%. Under normal circumstances, I believe that most investors would use a WACC close to 10%:
I only needed to review the future free cash flow expected for the next few years. In my view, Gran Tierra looks quite undervalued. I assumed, like other financial analysts, sales in 2022 and 2023 close to $500 million and $700 million respectively. I also expect 2022 EBITDA to be close to $405 million, and 2026 EBITDA to stand at $2.65 billion.
Notice that my numbers are conservative. The FCF/Sales would decline from around 35% in 2022 to less than 16.5% in 2026. If we sum everything and divide by the share count, the implied share price would be equal to $1.5:
Notice that I did not even need to calculate the terminal value to see that the company is quite undervalued. Under the previous assumptions, management should be able to pay its debt obligations with future FCF. In 2026, in my view, management will have a lot of remaining proven reserves to produce oil.
I was extremely conservative with the calculation of the terminal value. The industry trades at a median of 7x. I used a terminal EBITDA of 1x because I cannot be sure about the amount of reserves that the company will have left in four years:
If we assume 2026 EBITDA of $2.65 billion, an exit multiple of 1x, and a WACC of 10%, the NPV of the terminal value would be close to $1.85 billion. If we adjust with the net debt, the figure should stand close to $1.25 billion. If we divide everything by the share count, the terminal value per share would equal $3. The sum of the terminal value per share and the future FCF discounted stands at $4.5-$5. The company is currently trading at $1-$2, so I believe that there is significant upside potential:
Risks From Underestimation Of Capital Expenditures Or Overestimation Of Reserves
Gran Tierra offered an evaluation of its reserves executed by an expert with many years of expertise in the evaluation of oil and gas properties.
McDaniel is a private firm established in 1955 whose business is the provision of independent geological and engineering services to the petroleum industry. McDaniel is among the largest evaluation firms in North America with over 60 professional and technical support personnel. Source: Report On Reserves
I do believe that management worked with consultants of prestige. However, professionals could fail. If management reported more proven reserves than expected, or capital expenditures or future operational expenditures are underestimated, future FCF may not be that significant. As a result, once the market learns about the reality of the project, the share price could decline significantly:
We make estimates of oil and natural gas reserves, upon which we base our financial projections and capital expenditure plans. We make these reserve estimates using various assumptions, including assumptions as to oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Some of these assumptions are inherently subjective, and the accuracy of our reserve estimates relies in part on the ability of our management team, engineers and other advisors to make accurate assumptions. Source: 10-k
Risk From Debt Holders
In order to receive financing, Gran Tierra Energy signed several agreements with banks and financial institutions. If management does not report sufficient amounts of oil production, it may not be able to pay its debt obligations in 2025. As a result, bankers may impose certain restrictions, which may reduce the company's ability to operate. In my view, if Gran Tierra Energy does not pay its obligations, the stock price may decline to a price mark close to the company's cash per share or lower.
Risks From Political Instability In Colombia and Ecuador
Gran Tierra Energy Inc. operates in Colombia and Ecuador, where political change occurs very often. Nationalization of the oil industry, increase in taxes, increase in royalties, or even guerilla war and narcotrafficking could be an issue. As a result, management may have to stop its operations, or the projects may not be that profitable. Under these detrimental case scenarios, I believe that the share price would collapse:
Both Colombia and Ecuador may experience future political and economic instability. Colombia has experienced social, economic and security turmoil related to security, guerilla and narcotrafficking. Political changes because of future electoral processes could result in new governments or the adoption of new policies, laws or regulations that might assume a substantially more hostile attitude toward foreign investment, including but not limited to: the imposition of additional taxes. Source: 10-k
Under this case scenario, even if political unrest doesn't affect the company's operations, the cost of capital may increase. If investors decide to leave Colombia, the company's cost of debt or cost of equity could increase. If we use a WACC of 30%, the implied fair price would be close to $1-$2:
Already reporting oil production and sales, Gran Tierra Energy Inc. is also expected to report a significant increase in future revenue and free cash flow. The company also calculated its proven reserves assuming an oil price, which is significantly lower than the current Brent price. Take into account that the invasion of Ukraine made the oil price spike up, which management couldn't foresee when it reported its proven reserves. In any case, the sum of the future free cash flow implies a valuation that is significantly higher than the current share price. I will be buying stock at the current share price.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of GTE 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.