(Note: This article was originally published in the Marketplace Newsletter on April 27, 2022 and contains updated information).
Yangarra Resources (OTCPK: YGRAF) is a Canadian company that reported C$0.26 per share in net income while generating C$0.46 cash flow. These types of numbers make this investment a very cheap investment at the current share price. The company reported those numbers significantly improved from last year, even though a third party curtailed some production in March 2022.
The current commodity price market allows the company to operate a full-time rig while paying down net debt of up to approximately C$179 million. Increasing production by more than 20% in one year combined with paying off about a third of the debt (as a goal) is a very profitable business that has few peers.
The company posted an impressive profit in the 2020 financial year when many companies lost money and had to write down the value of assets. In fact, this five-year history is impressive compared to the trials of much of the industry over the same period.
A company with a track record of earnings in tough times will have top-notch profitability when commodity prices are robust. The company has already made about half of its reported profits for the entire previous fiscal year. Commodity prices have only strengthened since then.
Since the first quarter, commodity prices have strengthened considerably. This company has exposure to the natural gas market as well as the liquids and oil market through a decent percentage of natural gas production. These wells are going to be extremely profitable in the current fiscal year. Shareholders should expect favorable guidance revisions following the second quarter report.
The stock price is not quite 3 times the first quarter annualized cash flow. This ratio could contract further unless commodity prices decline significantly from current levels. The company expects robust growth of over 20% in the current year and another 2,000 boe over the next two years. This company also has the money to pay a dividend once the debt level is deemed satisfactory. It is one of the few companies whose cost structure is low enough to allow both decent growth and the payment of dividends. Many companies can only grow slowly while paying a dividend once debt issues are resolved.
(Canadian dollars unless otherwise specified)
The flexibility of the company is explained by the extremely profitable wells. The performance of these drilled wells is extraordinary at prices well below current prices. These wells begin by producing a higher percentage of oil (which greatly helps the payback period) and then produce a less profitable mix as the wells age.
The rapid return on investment means management can (if they wish) drill two wells in the same year using the same capital. This money spent actually generates a lot more cash than a single well due to the quick return on investment. This is what allows for relatively rapid growth in output while paying off debt first and then a dividend later.
The company also has a geographic advantage as it drills a gap that few others are currently developing. Land is relatively cheap in Canada. Thus, this company acquires more acreage at a considerably lower cost than in the United States.
Even though the cost of the area is not usually part of a financial balance presentation to the shareholders, this lower location cost strongly influences the profitability of the company. Lower location cost is one less thing that needs to be repaid with a lot of money.
Both management and the board have experience in building and selling businesses. This will substantially reduce “small business risk” (although it will not eliminate that risk). It also means that the odds of this business eventually being sold are likely higher than it is “on average.”
Some signs of management experience would be the start of drilling in a relatively new area in 2015, when the industry was suffering from a major drop in commodity prices. This company then demonstrated the profitability of the new area as shown above.
At a time when many managements will pay almost full price or a small discount to drill highly profitable fields, it takes unusual management to find a new highly profitable place to produce oil. Shareholders thus benefit from above-average profitability.
The likely outcome of this is the obvious growth of the current game for as long as possible. But this direction is more likely than most to find another low-cost path to growth should it become a priority in the future. The current area should occupy the direction for a very long time.
Additionally, much of Canada is made up of stacked intervals that contain petroleum. Chances are that other intervals on that same acreage will become viable or competitive with the current interval as technology continues to improve. There is also a good chance that secondary recovery techniques will lead to a longer production life than currently expected.
With such management, a company has a bright future ahead of it. Good management tends to surprise on the upside. It seems to be one of the best and most experienced managements in the industry.
Small businesses in this industry tend to be a risk area fraught with fraud, cost overruns, and general incompetence. That’s why it’s so important to find experienced leaders who have built and sold businesses before. There will be a public record of past treatment of investors and shareholders that even lenders use before deciding to lend money to new companies.
Yangarra’s management has indicated its willingness to reduce debt. At some point, management may even decide to pay off the debt completely. This year, it seems possible to reduce the debt stock by at least a third of the current balance. At this point, it will be up to management and its lenders to decide what debt balance is desirable to minimize financial risk in the future.
This was a company that had acquired leases and tested different well techniques. The decision to switch to a production company was made just before the challenges of the coronavirus arose. This company, fortunately, had just enough production to justify reasonable debt ratios given the economic challenges ahead. But the debt market now demands better ratios in the future. Fortunately, production was sufficient to cause debt ratios to fall sharply when commodity prices rose.
This is a company that is likely to resolve debt issues within a year or two. After that, it will be a management choice as to whether to return more money to shareholders or ramp up production quickly. Usually, a management that builds and sells businesses will choose to prioritize production growth. This means that this company is unlikely to be an income option for investors (probably ever). But the profitability of the well indicates substantial upside potential.
Personally, I usually hold the stock until management sells the company. I would only sell it myself if the stock got outrageously expensive with several years of growth embedded in the stock price. Right now, the opposite is true. Thus, the stock can be considered for purchase for those who want a cheap entry into the industry. This management has treated investors well in the past. This is therefore likely to happen again in the future.