Strathcona Resources Ltd

TSX:SCR

Earnings Call Analysis

Strathcona's Strong Q4 Performance & Outlook

In Q4 2023, Strathcona Resources Limited maintained production at 186,000 BOE per day, with a record 60,000 BOE per day from its Cold Lake Thermal segment. The company generated $470.8 million in cash flow or $2.20 per share. Strathcona simplified its capital structure, paying off a term loan ahead of schedule, and increased its credit facility to $2.5 billion, maturing in March 2028. They deferred production from gas wells due to current low prices, slightly decreasing projected annual production. The company is close to reaching its net debt target of $2.5 billion, likely hitting it mid-2024. It plans to return capital to shareholders, possibly through dividends, after reaching this target. Additionally, the firm improved its profitability by shifting crude sales in the Gulf Coast to a termed-out basis, eliminating a $5-$10 discount on nearly 40% of its barrels.

Strathcona Resources' Robust Q4 Earnings and Operational Achievements

In the final quarter of 2023, Strathcona Resources impressed with their operational efficiency and financial fortitude. CEO Rob Morgan, CFO Connor Waterous, and Treasurer Angie Lau announced a production on target of 186,000 BOE per day, with the Cold Lake Thermal segment posting a record output of 60,000 BOE per day. Cash flow from operations hit $470.8 million ($2.20 per share), and free cash flow was a solid $150.8 million ($0.70 per share). The company's proactive financial strategy allowed them to pay off their term loan ahead of its February 2024 maturity, enhancing their capital structure significantly.

Adjusting to Market Conditions and Modifying Guidance

Acknowledging unpredictable energy markets, Strathcona adopted a prudent approach by deferring the activation of three dry gas wells at Groundbirch, awaiting better natural gas prices expected in winter. This maneuver, sensitive to market conditions, will reduce their average yearly production by roughly 15 million cubic feet per day. Consequently, Strathcona adjusted their guidance to reflect these changes.

A Promising Future: Debt Reduction and Shareholder Returns

Looking ahead, Strathcona calculated a near-future net debt drop to $2.5 billion, down from Q4's $2.7 billion, predicting achievement in mid-2024. Post-target, significant shareholder returns seem imminent, with plans for consistent base plus variable dividends. Important here is that Strathcona foresees no need for further debt reduction beyond $2.5 billion, hinting at substantial cash being funneled back to shareholders.

Expansion in Rail Transport Yields Optimistic Pricing Outcomes

Strathcona has ensured that all its Gulf Coast crude by rail sales will be executed under long-term agreements rather than spot market sales starting March this year. This strategy foretells a lucrative swing - potentially around $5 to $10 per barrel - on about one-third of the 30,000 barrels per day shipped to this market, previously sold at a discount. A steadfast volume of roughly 30,000 barrels per day is expected throughout 2024.

Investing in Organic Growth and Infrastructure Optimizations

Continuing its growth trajectory, Strathcona focuses on organic expansion and infrastructure upgrades such as incremental steam generation capacity, set to activate more robustly in the latter part of 2025 into 2026. These upgrades will presumably allow Strathcona to leverage their existing assets for greater production and efficiency.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning. My name is Joanna, and I will be your conference operator today. I would like to welcome everyone to the Q4 2023 Conference Call of Strathcona Resources Limited. [Operator Instructions]

I now introduce Rob Morgan, President and CEO Strathcona, to begin the conference.

[Robert Morgan, executive]

Good morning, everyone, and thank you for joining us. Welcome to the Fourth Quarter 2023 Conference Call of Strathcona Resources. I am Rob Morgan, President and CEO of Strathcona, and with me today is Connor Waterous, Senior Vice President and CFO; and Angie Lau, our Treasurer.

Yesterday, Strathcona released its fourth quarter and annual 2023 results, a summary of which was included in yesterday's press release with full details available on Strathcona's website as well as on SEDAR+. As a reminder, on March 11, we released sales of our year-end reserves and provided shareholders with a look at how Strathcona has grown and created value in the private market over the last 7 years.

I would encourage prospective shareholders to visit our website and review our 2023 reserves overview. Production for the fourth quarter was [ on plan ] at 186,000 BOE per day, highlighted by record performance at our Cold Lake Thermal segment at 60,000 BOE per day.

Cash flow from operations was $470.8 million or $2.20 per share, with free cash flow of $150.8 million or $0.70 per share. We finished the year with a simplified capital structure as we were able to pay off our term loan ahead of the February 2024 maturity. And we are also pleased to announce an increase in our covenant-based syndicated credit facility from $2.3 billion to $2.5 billion with a revised maturity of March 2028. As we approach the end of the first quarter, we are very encouraged by the signs of [ landfill ] occurring on the Trans Mountain expansion pipeline. As a reminder, Strathcona's oil-weighted production base is highly leveraged to WCS prices with a USD 1 move in the WCS differential or top line WTI equating to $40 million of annual cash flow.

Strathcona's 2024 development plan included production from 3 dry gas wells at our Groundbirch property in Northeast B.C. We spudded the wells in the first quarter and expected to complete them this spring. But given weak natural gas prices, we are choosing to defer bringing the wells on until the winter months when we expect much improved pricing. This will impact Strathcona's year average production by approximately 15 million cubic feet per day, and we have adjusted our guidance accordingly.

I would like to thank the entire team at Strathcona for their tireless work over the course of 2023 as we emerge from the private world into public markets, and we are very excited about what the future holds.

I would also like to thank our new public shareholders for the confidence you have placed in us. We are conscious that building a public track record takes time, but we're looking forward to sharing the accomplishments as well as the setbacks that we might have on this journey with you.

Thank you for joining us this morning, and we will be pleased to take any questions you might have.

[Operator]

[Operator Instructions] First question comes from Greg Pardy at RBC Capital Markets.

[Greg Pardy, analyst]

A couple of questions, maybe just on the financial side. And hitting the $2.5 billion net debt target, does that look like you're on track there to hit that in the first quarter. What does the timing look like?

And then maybe just in terms of shareholder returns that might come after that, understanding it might be a dividend, might be variable dividends or what have you. Is there actually any appetite for buybacks, just given the limited float.

[Connor Waterous, executive]

Sure. So Greg, on the timing of hitting our $2.5 billion of debt target. So we finished Q4 2023 with about $2.7 billion of debt. We're only about $165 million shy of that $2.5 billion. So we think we're going to hit that in the mid-2024 time frame. It's important to bear in mind that we ended 2023 with a slightly bigger working capital deficit than we think we'll probably have on a more a go-forward basis. So the first couple of quarters of the year might see a bit of a pay down of that at a working capital deficit, but certainly something that we think we are very much on track for soon.

In terms of what the framework will look like in terms of paying back capital to the owners of the business, post hitting that $2.5 billion of debt, I think our plan is certainly still the same of a combination plus a base plus a variable dividend. The base dividend is going to be sized so that it is always fully funded at a trough point in the price cycle. And then it will be a bunch of variable dividends beyond that.

The important thing, I think, for our shareholders to know is that fundamentally, we don't see a need of paying down debt past that $2.5 billion level. So if we aren't going to pay down debt, well, that means that the vast share of the cash will be going back out to the owners of the business.

[Greg Pardy, analyst]

Okay. Got it. And I guess just apologies for a follow-up. But in completely shifting gears, so you talked about the unit train facility expansion. I'm just wondering, can you give us an idea as to what does that mean in terms of how many barrels you now plan to ship? And then the other part related to that is, just in terms of the premium you're getting to WCS in the Gulf Coast? Just any color there would be great.

[Connor Waterous, executive]

Sure. So in terms of the total volumes that are going to be shipped by our rail business down to the Gulf Coast, it's still going to be plus or minus 30,000 total barrels a day for the calendar '24 year, which is pretty much the same volume we had over the 2023 year. The difference for '24 versus 2023 is that close to 40% of the volumes we sold in the Gulf Coast were sold into the so-called spot market down there. And the price that we get for our spot barrels on the Gulf Coast isn't as good as the price that we set as part of a medium to long-term crude purchase agreement.

What this new plant that we have set up down in the Gulf Coast means for us is that effectively 100% of all crude by rail that we sell in the Gulf Coast as of March of this year is all going to be sold on a [ termed-out ] basis. So there's not going to be any barrels sold in the Gulf Coast spot market. What in turn, that means is there was probably 1/3 to 40% of our barrels over the course of '23 getting a, let's call it, $5 to $10 discount to the base WCS Houston price. And now all of those barrels are going to be sold at a premium to the benchmark price. So it's a, call it, $5 to $10 per barrel swing on about 1/3 of that 30,000 per barrel that we sell down on the Gulf Coast.

[Operator]

Next question comes from Menno Hulshof at TD Cowen.

[Menno Hulshof, analyst]

Maybe I'll just follow up with a question on Greg's line of questioning. Should we just assume that it's going to be a flat 30,000 barrels per day of unblended crude by rail to the Gulf Coast from here on in then or does that -- is there any reason to expect that to fluctuate with what heavy differentials do? Or is there no tie whatsoever?

[Robert Morgan, executive]

No, there's no real tie to the heavy differentials. It should be relatively flat across the year.

[Connor Waterous, executive]

Yes. And the key on that, Menno, is we think the net realized price post transportation that we get on our crude by rail barrels certainly post this new premium is going to be at or better than the pipe a netback that we get down to a, call it, $10 local differential on the WCS benchmark.

[Menno Hulshof, analyst]

Okay. That makes sense. And then maybe I'll just flip over to M&A since it's been such a big part of the growth story. What are you seeing in the market today in terms of the opportunity set and how are those opportunities competing for capital with organic development?

[Robert Morgan, executive]

Yes. So thanks for the question. The -- as we've talked about, done 10 transactions over the last 7 years, the first 9 transactions with cash. Obviously, our last one was equity-based. Where you're seeing us talk about our cash flow and how the use of proceeds of our business is that we're focusing on that $2.5 billion debt target and then announcing -- following achieving that target, a shareholder return policy where as Connor highlighted, we would expect to return a majority of our free cash flow to shareholders. So using cash at this point for M&A activity is not something that we're focused on.

We did obviously now have a public listing and part of our rationale of getting a public listing was to potentially use our equity for M&A transactions. But I think as we've highlighted, building a space in the public markets is going to take a bit of time and the current valuation of our shares is we just don't feel that it makes sense using that equity for M&A transactions. So our focus is, from a returns perspective, we think reinvesting in the business, growing organically which we have done over the last 7 years is the best use of our cash at this point in time. And we'll obviously keep an eye on the market and see what opportunities may occur. But I think in the near term, you'll see us focus on that organic growth.

[Operator]

[Operator Instructions] Next question comes from Dennis Fong CIBC World Markets.

[Dennis Fong, analyst]

My first one might follow on a little bit from Menno's second question there. I was hoping you could elaborate a little bit more about the strength in production from Cold Lake. Obviously, you're seeing a good ramp from Tucker H-pad. Can you talk a little bit about where the production from that pad could go?

And secondarily, maybe touch on Lindbergh a little bit as well. I want to understand what the production trajectory happens to be for this asset this year and where it could maybe get to over the next 12 to 18 months?

[Robert Morgan, executive]

Sure. Thanks, Dennis. As we look at Tucker, obviously, the 8 well pairs that we drilled had -- were some of the first well pairs at Tucker since 2017. And it was really a combination of the initial production from those well pairs, which I think we've generally ramped up to fairly full capacity and -- but also the reactivations of the -- some of the legacy well pairs that had been shut in for quite some time given how the heat now has been distributed in the reservoir has really supported that production base at Tucker.

We are in the process of drilling another new pad at Tucker, but we don't expect that production growth to come on until later '25 into that sort of 2026 time frame given the profile of the ramp-up of those pads. As we look at Lindbergh, yes, we've had some very good response to some of the very basic debottlenecking work that we've done of that asset. And I think with the plan that we have in place of installing some incremental steam generation capacity, again, a lot of that activity comes on is sort of later 2025 into 2026.

So we'll see a bit of ramp through the part of -- latter part of 2024 and then a lot more of that growth into 2025 and 2026 on those Thermal assets. But we think we're on track towards ultimately filling that capacity as we've highlighted over the next couple of years.

[Dennis Fong, analyst]

Great. I appreciate that color. Switching up a little bit towards hedging, saw some kind of reorganization of the contracts that you had there. Can you discuss how you think about this, we'll call it, refreshed commodity risk program and potentially what that means for, we'll call it, cash flow stability and pre-cash flow, sustainability or generation or the ability to cover CapEx and generate free cash over the next few years?

[Connor Waterous, executive]

Sure. Thanks, Dennis. So when we look at what the hedge book looks like now at the end of March, we effectively just have a little bit of a legacy [ TI ] swaps in place over the first part of Q2 and then have some gas [ callers ] in place through May. When you look at how we built the business in the last 7 years, in general, we've had quite a strong hedge profile business. And in part, what has driven that is we've built the business in close partnership with our bank group. And part of getting that capital from our banks is an ongoing mandate to put hedges in place.

When we think about what the balance sheet looks like now and as Rob said, a view that we're probably not going to be doing any kind of big cash transactions in the near term. What that in turn means is that the focus on trying to put swaps and other sorts of contracts in place is just a lot less than it used to be.

So I think you'll still see us do some hedging with the business going forward, but it will be much more with [ callers ] where the floor of that [ caller ] is picked to make sure that even in a real trough point in the oil and gas price cycle, that the balance sheet is still in a very strong shape and not as a way to a lock in revenue, so to speak.

[Operator]

That is all for questions. I will turn the call back to Rob Morgan for closing remarks.

[Robert Morgan, executive]

All right. Well, thank you very much for joining us this morning, and we look forward to discussing our first quarter remarks in May of this year. Thanks very much, and have a great day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.