Pine Cliff Energy Ltd

TSX:PNE

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Kristopher Zack, executive]

Thanks. Good morning, everybody. Thank you for joining us on our second quarter conference call. [Operator Instructions] At this point in time, I'm now going to turn the call over to our President and Chief Executive Officer, Philip Hodge.

[Philip Hodge, executive]

Thanks, Chris. Good morning, everybody. I think we will -- as we've done in the last couple of webcasts, we will assume that everybody has read the press release, and you may have -- you probably have read my President's letter. But I will summarize a little bit of what we kind of put in there, provide a little color.

This really is an opportunity for you to ask some questions if you have any questions and you can just forward them online, and we'll read them and happy to answer them. Thanks to those who have already put some questions in the queue. As I mentioned in the President's letter, it's kind of an odd -- it is an odd time in the natural gas producer space. This is our -- now we're in our 13th year of running Pine Cliff. And it's never -- we've never had a situation where we've had depressed natural gas prices in the summer and a really strong forward outlook on natural gas prices.

We've had difficult gas prices before. That's not new. 2019, 2020 would be prime years to show that. But as we saw coming out of those years when gas prices got a lot stronger, it feels like that same type of setup. The difference this time, though, is that I think the markets are already building that in. In other words, they've already -- the forward strip and which is what you can hedge your natural gas prices forward at is already reflecting the fact that there is going to be significant demand coming into the North American market in the back half of this year and into 2025.

And I know that for many years, we've been talking about LNG being the prime kind of support for that increased demand. But it's not -- it's coming from a lot of other sources. It's not just LNG. The LNG, I don't want to diminish that because that is quite -- especially from a Canadian perspective, quite monumental. We've never had the ability to export natural gas to any other continent -- sorry, any other country than United States, and that's about to change. And it's going to have a pretty radical impact on kind of the dynamics of the supply and demand here in Western Canada because we -- the old adage was that we were always producing gas at the wrong end of the pipe.

In other words, we had to send the gas South. We had to send the gas East, and we had to pay the marketing cost to do that. We now are going to have the ability to send gas West, and to have the ability to send that to -- in fairly large quantities. Over 10% of all of our production of our current production will now be exported by -- as LNG starting 2025.

But compounding on that, and I touched on that in both my e-mail, if you're a subscriber. If you're not a subscriber to our e-mail, you can sign up on our website. But in the e-mail, I talk about the fact that we've got Mexico LNG also starting up at the exact same time. And we've got a very large increase happening out of the Gulf of Mexico in the United States.

The United States has now become the largest LNG exporter in the world, having started from 0 in 2016. So it's been extremely impressive. And they're now exporting between 13 and 14 Bcf a day. That number is going to go to over 28 Bcf a day in the next few years. That's significant. And so it's kind of this unique time in the market. I understand the frustration that shareholders have because we're all shareholders.

And so we all would like the stock price to be higher. I think we've -- however, we've always managed Pine Cliff for the long term and not the short term. And from that perspective, we -- that's why back in March, we reduced our dividend because we didn't want to be sustaining the dividend with debt. We want to maintain that we can do it within cash flow.

We watch that very, very closely what we call kind of our payout ratio to make sure that our cash that we're paying out either by way of dividend and all of the costs of doing our business are not greater than what we're bringing in. It is -- I think the #1 surprise, just reading some of the analyst reports that came out last night on us after the financials, I think people were surprised that our realized price was as strong as it was.

And that's not surprising because that's not really transparent because that's a lot of the work that goes behind the scenes on selling gas forward on a monthly basis, not just on the hedge basis, which we are -- that's what you see in the financial statements.

And that -- the hedge position is the largest position we've ever had in the history of Pine Cliff going into the summer. We expected to have a volatile summer. We were -- it has delivered in spades. It's been a very volatile summer for natural gas prices. But is -- we're very comfortable with where we've position the company to get through 2024 and then still be able to capitalize in 2025.

The -- I think the -- when I look at -- as an investor, I mean, one of the questions we got with how do we value Pine Cliff? And it's a very valid question because I think with a lot of oil and gas companies, there's many different ways to value it, and it kind of depends on the business model.

And if you've got a business model, for instance, that is very actively drilling and that you're -- you have a lot of web, you've a lot of rigs moving all the time. A very important part of that is what the inventory is. Are you able to maintain that production increases to offset the decline. The average natural gas decline, the average producer in our base in the public markets has a 30% decline rate, 31% actually.

And so that's -- it's very important for us because of the low decline rate. And let me say, that's not an answer to all ills. I mean it is just at a different business model. From my perspective, what it then becomes is how much cash flow can you generate? And how much can you return to your shareholders?

And that, I think, is what is going to get focused on more and more as we go into 2025. It's going to be on the free cash flow yield. When I talk about free cash flow yield, we talk about after all of your costs for essentially keeping production flat, though. You got to make sure you're comparing apples-to-apples.

In 2024, we cut our CapEx considerably. And that was obviously by design. We really do not believe it's -- this is a year to be bringing on new wells into weak commodity prices. So because of that, we're -- we've let our production decline. Now it's not -- like as we talked about, it's a low decline but nevertheless, it's declining. The plan would be in 2025 that we would start to go back to our typical program, which is a modest drilling program that allows us to keep the kind of production roughly flat and allows us to generate as much free cash flow as possible, cash flow that we can return to the shareholders.

One of the other questions we got is the plan for the debt repayments. That ties into that. With the free cash flow that we've got in 2025, our plan would be to continue to make the payments that we're making currently.

And we've made -- we're paying down $2 million every quarter against our principal debt. The plan is to continue to make those payments every quarter and knock that debt down. Depending on the forward strip is -- and no one knows exactly what commodity prices are going to be next year. But I think most analysts with their forward strips have got us anywhere -- somewhere in the $80 million cash flow range.

If that is a range that we're able to achieve and our debt is -- our long-term debt is like $60 million then clearly, we're back within and under the 1x debt to cash flow, which is a goal that we've always had to try to keep the debt under 1x. Currently, we're under 2x, but our view is that we'll get back to under 1x in 2025.

And the reason we want to do that is that it gives us a strong balance sheet in case there's any acquisitions that are going to make sense to us. The -- we are still very much a company that has grown and continues to look at acquisitions as a -- for future growth.

And so we've gone from 100 barrels a day to over 24,000 by making what we believe to be a very smart, accretive, disciplined acquisitions over the last 13 years. So we did a $106 million acquisition in December of 2023. That's the acquisition that we're now paying down. It's turned out to be from a production and asset standpoint to be a very good acquisition.

Those assets are continuing to perform exactly as we hoped they would. The -- we will -- we think there's going to be opportunities in the back half of this year and into 2025 to make other acquisitions that will be a good fit for our model, and we'll be very active looking at those types of acquisitions.

But you never know, we don't control that timing. We don't control what vendors are willing to sell the assets for. So you just need to be prepared. We're very proud of the fact that we have not used any equity since 2019 to do any of the acquisitions, even though we've done multiple acquisitions in between that 2019 and now.

Again, that's driven by the fact that we're big shareholders. I mean the management owns a lot of stock. Our insiders. We talked -- have been with us a long time. I think they have been with us a long time because they fully appreciate the fact that we are very disciplined on our acquisitions.

And that's not going to change. Because like I said, everything has to make sense on a per share basis because we are big shareholders. So it's -- like I said, Q2 is always kind of a softer kind of generally quarter for -- in the natural gas space because it's the beginning of summer.

Q3 is going to -- is looking a lot like Q2. Here, we're already where -- we're 7 weeks away from the end of Q3. We continue to keep a sharp focus on making sure that we're able to continue to pay down the dividends and stay within our covenants and again, prepare ourselves for what's coming in the back half of this year and into next year.

Another question we had was about the shorting of our -- of any stock. So I guess the question was more framed in the fact that the Wall Street is -- seems to be paying high rates of return to low in stock for shorts. We've never had much of a short position against Pine Cliff. We're always one of the lowest percentage ones. And I think there's a couple of reasons for that.

One is because we pay a pretty good dividend. And so anybody who's short stocks has to deal with that, we also pay it monthly. So that makes it even a little bit more complex for those who are trying to short stock. But I think probably the biggest reason is we have a lot of very large shareholders who are not loaning their stock to people to have shorts on them.

So it's -- our liquidity to -- for the short market isn't very strong. So I think that's historically -- like I say, in 13 years, it's been very few times that we've had any kind of significant shorting against the stock. And I think that continues today. I mean, today, our yield would be close to 7%. I mean that's a pretty strong dividend yield, especially given the fact that we've -- it is a time or natural gas commodity is quite weak.

I'm -- we're -- I'm not going to try to call a bottom but it sure feels like we're pretty close to the bottom on the natural gas commodity prices. They're just -- we're now -- I think the #1 reason that there's been such a depression around natural gas prices is a fear that storage could fill in both the United States and Canada this summer.

And the reason for that is because we've come off 2 very warm winters. And because of that, not as much gas was used in the heating in the winters and therefore, we came into the spring with more gas in place. The U.S. has done a good job of cutting production. When gas prices went under $2, there was large producers that came out very vocally saying that they were going to cut production. That continues today.

And so they -- I think there is generally a belief that storage is going to finish in October, somewhere around 3.8 or 3.9 Tcf. That is under the capacity levels of -- so that's a good thing. So I think as people get more and more comfortable that, that's -- that there isn't going to be situation where storage is going to fill, then prices in the United States should continue to rise.

In Canada, it's a little bit more complex because this is -- goes back to the LNG. This is the very first time that we've ever as an industry, have to prepare for the fact that more than 10% of our production is -- or an increase in demand is going to go up by more than 10% in the next 6 to 9 months. And so production has been pretty resilient, has stayed pretty up around that 18 Bcf a day.

That being said, in the last few weeks, we've seen it come down a little bit as well. So it's going to be interesting. There's -- when you do winter drilling, a lot of the companies that are having very active drilling programs, would have committed to those rigs and those crews in the winter. And they -- because the plan would have been for a more moderate or more average winter, and that didn't happen. But you've already committed to the drilling.

Those rigs, those well -- the production from those wells would have come on in the spring. And then they've now -- there's a natural decline. There's a very high initial rates of production for those wells. That's starting to wane a little bit. And so that is probably having an impact on how much supply. And you've got some -- a lot of the maintenance projects for the pipelines and also for the producers, producers tend to plan their turnarounds and their workovers on any of their facilities at the same time that in the summer and also at the same time that TC Energy is having maintenance turnarounds.

So that's -- there's still more of that to happen in August. We've got some maintenance starting up here on next Monday that will impact production just like it did in July. So there's -- and then again, then we're into September, October, and that's a bit of a wildcard for weather. You never know what you're going to get in Canada in those months.

So it's an interesting time. I think what makes me comfortable as the Pine Cliff shareholder is that things look very -- a lot stronger in the winter and in going to 2025. We've got gas prices, the forward strip is in around that $2.50 level. At those levels, Pine Cliff does very well on a cash flow basis and from -- it becomes a situation where we -- we will then have excess capital to determine how we want to allocate it.

And I think at the end of the day, that's what our shareholders look to us to do. And I think hopefully have gain confidence in our ability to do that over the last 13 years is how do we allocate capital? Is there acquisitions that make sense? Is there drilling that makes sense? Does it make sense for us to increase our dividend. We've increased the dividend twice since we started it in 2022.

We've decreased it once because it was prudent in our view to do that at the same time. I think by the end of this year, we're somewhere around $95 million. I think we've paid out in dividends if we maintain the current rate. That's pretty impressive for a company of our size -- for a company that's got an enterprise value of $400 million, have just started up our dividend 2 years ago.

So that's the power of the business model that we've built is that it has the ability to generate a lot of free cash flow. And because we don't spend as much as others on drilling CapEx, we can therefore give that excess cash flow back to shareholders. That's the plan.

And it also will give us a cost of capital that will allow us to take advantage of acquisition opportunities should they present themselves. So I think the -- that's kind of the summary of kind of where we're at the quarter. I think between the press release and my letter and the e-mail that we sent out, I think you should have a pretty good sense of how we're viewing the world these days and how we're kind of -- why we can remain very positive shareholders of Pine Cliff.

It's been interesting doing some of the investor meetings, and we're going to ramp up our Investor Relations work here. And as we head into the fall because I think natural gas is going to become very topical. I think Canadian natural gas, in particular, is going to become very topical. There's a lot of -- some of the other headwinds that we've -- or tailwinds we've talked about previously with you in various formats is we've got the oil sands production rising because of the TMX pipeline and that increases the local natural gas demand.

I can speak from personal -- we read all about these data centers, but it's also hitting at a personal level because we've had various discussions with different parties about how the data center model works because they need very reliable power for their -- for those operations, and that seems to be an area that is growing very rapidly, and that's coming at us quickly.

I mean that was -- that's just in the last kind of 12 months that that's been on our data or on our radar. But there's -- we've got the several major capital projects in Alberta, including the ATCO pipeline that's being built. There's been ethanol projects in Northern Alberta. The very last call facility came off with Red in Alberta in 2024. So there's a -- again, a lot of reasons to be optimistic for a natural gas producer going forward. We protected ourselves with hedges in the back half of this year substantially more than we have in the past.

Again, because we're not -- although we're very optimistic in the future, we're not sure when that future is going to kick in.

[Philip Hodge, executive]

So we've got another question just added here. Does the -- how do you value P&A? The market seems to value P&A on its dividend yield. The share price seems to move in lockstep with the dividend yield of other gas producers, do you agree?

I think that definitely the dividend yield is an important part to how our investors now value Pine Cliff. I would agree with that. I think we -- before, it was purely about cash flow and how much cash flow we could generate. I mean, going in, we did -- in 2022 -- well, go back to 2021, we did $59 million of cash flow in 1 year, and that was the best year in the history of Pine Cliff. And that was pre-dividend.

And then in 2022, when gas prices rose, and that's the kind of environment I think we're heading into and we did $163 million of cash flow in that. We did $55 million in one quarter. That's when the dividend got put in place. So I think then it becomes a much more stronger or much more definitive way to value Pine Cliff because the dividend yield is very easy to calculate right in front of you. And it's a lot -- then as opposed to trying to guess what we're going to do with excess cash flow.

Because like I said, there are other ways to -- for us to use that capital on paying down debt or doing acquisitions. I don't know, Kris, if you have anything to add to that question?

[Kristopher Zack, executive]

No. I think the dividend yield certainly provides a bit of a floor on our valuation, obviously. But as commodity prices improve and what we're seeing in 2025, we'll have excess cash flow in addition to that dividend payment. And I think that's where it will get a little bit more credit for that incremental cash flow because then we can deploy that capsule in ways that are accretive for our shareholders, whether that's through acquisition, whether that's through debt repayment or whether that's through incremental payments to shareholders.

[Philip Hodge, executive]

Another question we've got here is regarding our inventory profile since we've done the Certus acquisition in December. And how has that changed? That's a really good question because the -- I was commenting to my Board of Directors yesterday on this very same topic. We have never had the inventory optionality that we have today.

We've got 3 areas that were very -- all of which are -- have a very good high economic prospects for drilling. And therefore, we're going to have to determine again going back to capital allocation, we're the best place to spend that is. One is the -- our traditional -- the twining area, which is where we've done all of our drilling -- our modest drilling efforts over the last 3, 4 years have all been in that area.

The second one is the Carolina area, which is the -- they came with the Certus assets mostly focused there. So the twinning areas, Pekisko oil mainly focused. Now it comes with a substantial amount of gas with that oil. The Glauconite oil in the Carolina area, we've been [Audio Gap] area, you really want to be doing 2-mile wells.

And so everybody knows that. And so there's been swapping that's been going on to enable all the parties to get more pieces of land that allow them to be able to do 2-mile wells. We haven't mentioned that a lot to investors, but it's getting -- there's a lot of activity in the area around our lands.

So obviously, when you have got a lot of activity and a lot of partners in and around your land base, that creates different opportunities for partnerships, for 2025. And on a forward strip basis, we will go back to a more traditional drilling program. We haven't yet set the budget for 2025. But that what we need to determine is where do we want to spend it.

Having this debate internally something that I've never experienced here at Pine Cliff before because we've never had multiple areas that all generate really strong rates of return. We're talking about -- in many of these areas, we're talking about less than 1-year paybacks. And so those are very good opportunities, we're going to have to determine what the best way to do it. Some of it depends on partners in the area, and -- it's going to be a very active time.

We brought in, we've got more geology help and land help within our team that we've never had before to allow us to be able to get ready to exploit these areas. And so it's quite exciting around here. Another question was other than more favorable macro conditions, how do you envision growing the dividend?

Well, we just touched on that a little bit. I think that the -- one thing that I don't think people fully appreciate and I -- some of the analysts pointed this out yesterday and I think they're accurate in pointing it out that acquisition that we did in December of 2023, if we had not done that acquisition, I don't think our dividend would be able to be -- we wouldn't be able to sustain it at the level it's at today. Having liquids and having NGLs is part of our production mix has turned out to be extremely important part of the sustainability of our dividend.

So if the oil prices and NGL prices continue to stay strong in 2025, and when I say strong, that's kind of above $70, which is above what they are today, then that's going to allow us to maintain or to have a drill program that will also be able to help support the sustainability of the dividend. And I think the way we look at the business now and the way we look at any acquisition we do is how does this help us sustain and hopefully grow the dividend.

Like I said, it's not a true variable dividend. There isn't a formula that we've put out to the market and said, this is when it's going to go up and this is when it's going to go down. But you can see from our actions that we're going to be -- watch the payout ratio on our entire business. What are cash flows coming in and what are cash flows going out?

And what is left over from that -- that allows us to get more comfort level around. We've talked about a payout ratio in -- we think that because of our low decline maybe have a higher payout ratio than a lot of the other producers in the space. And so if our payout ratio is somewhere in that between 70% and 80% or 70% and 85%, that's a pretty comfortable level because there isn't a lot of moving pieces in our business model.

If that's the case, you can again back look at what we could potentially do for cash flow going forward, and that opens up cash flow that we can pay out. Again, there's always going to be acquisitions for us to look at. And so we'll -- that will have to be built into where we think capital should be best allocated. But the plan clearly is to grow the dividend.

And I think that, in our view, we'll be able to do it in a couple of ways. One is we believe the commodity prices are going to be rising, and we also think that our drilling inventory is going to be able to increase our mix and our cash flow. I don't know, Kris, is anything I think...

[Kristopher Zack, executive]

That's a really good summary.

[Philip Hodge, executive]

Another question is, are there any opportunities for infrastructure dispositions to accelerate balance sheet deleveraging?

We've had we've had different players approach us on infrastructure. For instance, the Aiden pipeline is one, which is the pipeline that goes in the United States. That's one that we've had different discussions with different groups on. We -- because we own over 80% of our infrastructure, that's a pretty key piece to why we've been able to maintain our low operating costs.

So we're not -- we haven't yet seen a business situation or a business offer that would seem to make good sense for us to dispose of our infrastructure. But that doesn't mean that couldn't happen in the future. We're very sensitive to the fact that, especially at times like this, when people see our higher realized price, even though the AECO price was as low as it was in Q2.

One of the reasons is because we own our infrastructure. And if we didn't own our infrastructure, then it's possible that your variable costs are going to continue to rise and therefore, you're going to probably have to shut in production. For us, we watch it closely. But because we own our own infrastructure because we're going through our own system, that our breakeven point is a lot lower. And so therefore, we're able to maintain production through difficult periods of time.

So I wouldn't say never to infrastructure dispositions, but it's not something that we're actively seeking either. We quite like when we go in to buy assets. If they own their infrastructure, that's definitely a positive on things we look at. Some really good questions this quarter. Thank you. We appreciate it. I think everybody who's listening or anyone who follows us knows that we're very accessible.

So if there's any follow-up questions, just e-mail us, give us a call. Like I said, if you're not already an e-mail subscriber, you can get on that list on our website. We'll be putting this recording on to our website for those who weren't able to attend today. Thank you for those who were able to attend. I appreciate it very much, and thanks for the support.