This company presents a good opportunity for investors with a minimum of risk, with exceptions as noted. Enerplus, (NYSE:ERF) is a Canadian driller with a good balance sheet and cash flow, that may benefit from the thesis we presented in our introductory article on several Canadian drillers last month. Readers should refer back to it for a detailed analysis of why the Canadian drillers are of interest.
The thesis for buying Canadian drillers, that I presented in the Omnibus article works mostly for ERF, as regards their Canadian water-flood activity. The drawback to ERF is that most of their daily production is in the U.S. in areas that may come under challenge from logistical, market pressure, and political ramifications of events outside their direct control.
In this article we will take a brief look at their primary assets, but focus on a couple of key areas-cash flow generation and debt maturities. What we don’t want to do is sink money into a company that doesn’t have staying power. ERF doesn’t fall into this category and could find a catalyst for growth in two areas. We’ll focus on the possible catalysts in my concluding remarks in the “Your Takeaway” section.
Ian Dundas, ERF CEO mentioned possible “staying power” concerns in the frame fairly succinctly in comments in their Q-2 conference call-
“The last six months have put a spotlight on risk management and the importance of maintaining flexibility, strong execution and a solid financial foundation. This crisis will accelerate the bifurcation in our industry between those companies that are well positioned with flexibility demanded through this period without destroying shareholder value and those that do not. We see Enerplus being in the first camp.”
Let’s see how they back this up.
The company produces oil and natural gas-herein referred to as “Natty,” across a fairly compact geographic area, but spanning two countries. In Q-2 ERF produced 87K BOE with 48K of that being in liquids.
Negative price differentials ($5.00/bbl) set against WTI which has only just reached a level where most Permian operators can bank a buck or two on a barrel, represent a challenge for much of their liquids. The same can be said for their Marcellus gas production, sold at -$0.45/MCF differential to the NYMEX contract. That said ERF generated $30 mm in the quarter of free cash, a run rate of ~$120 mm for the full year, perhaps improving as/if prices rise. A $630 mm non-cash charge against Goodwill and PP&E kept them out of the black for the quarter. Looking ahead to the rest of 2020, the company expects to keep production flat with a capex budget of $300, and a similar amount for 2021. With AFF at a run rate of ~370 mm than can cover their capex and pay a modest dividend, yielding just over 3%.
As they are generating free cash, their QoQ cash burn is minimal and can easily be maintained with cash on hand and access to their largely untapped credit line. They retired a 2020 maturity of $82 mm with cash in the Q-2. A similar maturity awaits them in 2021, and they have many levers to pull to meet it. It doesn’t bother me. Their net debt to AFF ratio of 1:1 puts them on fairly firm financial footing.
This is the biggest cash generator and an area where the company has done a good job in reducing drilling days to TD and increased frac stages per day. This increase in efficiency has lowered well costs by $1.4 mm since 2017. The Tier one quality of the acreage is borne out in the high oil-cut of their total production. They have a 10-yr+ inventory of drilling locations going forward, with 6-well spacing currently going to 10-well spacing per DSU in the future. Lower tier intervals are also available should prices rise enough to support their development.
This is a farm-in area for ERF for future planned growth in the DJ basin and contributes little non-operated production or cost currently. The ERF acreage appears to be top-quality looking at the structure map of the field.
This play is second largest cash generator with low costs due to high quality rock driving a nice cash margin of $0.62 MCF in spite of their pipeline differential noted above. The key to the Marcellus is being in the right spot and ERF ticks that box with their NE Pennsylvania acreage. I provided a structure map of the Marcellus in an OilPrice article last year. Have a look if this interests you.
This is a cash machine as the infrastructure is in place and the asset has a very low decline. The permeability is high enough that polymer flooding pays off. The company didn’t discuss this area much in their call, so I don’t have a lot to add to this commentary.
A point worth noting is the company’s focus on dry gas, means that there won’t associated sales of condensate and other heavy ends.
You will note in the slide above this operation is referred to as “low decline.” A little explanation is in order for the lay reader. Waterfloods are often a tertiary form of recovery designed to strip a last 10-15% from the original resource. There are Waterfloods in West Texas that have produced commercially for decades. The water drives the oil to older producing wells that would only make water without water injection. Polymer floods are a similar idea, but use the viscosity added by the polymer to provide an extra push in higher perm areas.
The two key risks for ERF are the ones I mentioned above-DAPL takeaway and the political risk for their DJ basin. A couple of years ago frackers in the DJ basin were hammered due to an anti-fracking measure that Colorado was contemplating at the time. The measure passed but the impact so far has been far less than feared. The outcome of the national election may reignite this concern.
The other risk is just gas. It’s volatile (pun intended naturally) in nature and seems to give the folks who follow it closely ulcers. As noted above ERF is generating cash from their production and seems to have higher quality acreage that will be produced preferentially, to mitigate the general risk I apply to gas.
A counter-point to that is that winter is coming. The heating season is nigh upon us and that is projected to drive natty to around $3.00 MCF by early Jan, 21. If you subscribe to that theory, ERF is an excellent way to put it the test.
The potential catalyst for ERF is primarily declining shale production from marginal producers. It’s worth a read as it underscores my concerns about liquidity as being first and foremost in our evaluation of these companies. Demand is increasing and fields that are caught up in litigation may falter.
The company seems to be fairly well managed, and is generating good and likely increasing cash flow at current WCS prices. On a price per flowing barrel equivalent basis they are pretty cheap at $6.36 PFBE. Their P/CF is pretty low as well at 1.72. The company has been an $8.00 stock in the last year and in a scenario where the write downs stop and the oil price cooperates just a hair, seemingly could hit that level again.