(Note: This article originally appeared in the Market Newsletter on April 27, 2022 and contains current information).
Yangarra Resources (OTCPK: YGRAF) is a Canadian company that reported C $ 0.26 per share of net income while generating C $ .46 cash flow. Such numbers make this investment very cheap at the current share price. The company reported much improved figures compared to last year, although a third limited production in March 2022.
The current strong commodity price market allows the company to run a full-time platform while paying off net debt of up to 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 partners.
The company made impressive profits in fiscal year 2020, when many companies lost money and had to deteriorate their asset value. In fact, this five-year history is impressive when compared to the evidence of much of the industry in the same time period.
A company with a track record of profit during difficult times will have a profitable return when times have robust commodity prices. The company has already earned about half of the profits reported throughout the 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 liquid and oil market through a decent percentage of natural gas production. These wells will be extremely profitable during the current fiscal year. Shareholders should expect favorable reviews of the guide as a result of the second quarter report.
The share price is not about 3 times the annualized cash flow of the first quarter. This ratio may shrink a little more unless commodity prices fall substantially below current levels. The company expects robust growth of more than 20% in the current fiscal year and another 2,000 BOE in the next two years. This company also has the money to pay a dividend once the debt levels are considered satisfactory. This is one of the few companies with a low enough cost structure to allow for decent growth and dividend payments. Many businesses can only grow slowly while paying a dividend once their debt problems are resolved.
(Canadian dollars unless otherwise specified)
The reason for the company’s flexibility is the extremely profitable wells. The performance of these perforated wells is extraordinary at much lower prices than at present. These wells start by producing a higher percentage of oil (which helps considerably in the payback period) and then produce a less profitable mix as the wells age.
Rapid recovery means that management can (if desired) drill two wells in the same year with the same capital. This money actually gets a lot more cash flow than a well because of the quick return. This is what allows for relatively rapid growth in production while paying off debt first and then a dividend.
The company also has a location advantage because it drills a range that few others are currently developing. Land is relatively cheap in Canada. Thus, this company acquires more space at a considerably lower cost than in the United States.
Although the cost of the surface is not usually part of a presentation to the break-even point shareholders, this lower cost of location greatly influences the company’s profitability. A lower placement cost is something less that has to be paid for with a lot of money.
Both management and the board of directors have experience in building and selling businesses. This will materially reduce the “small business risk” (though not eliminate that risk). It also means that the chances of this company being sold are probably higher than what happens “on average”.
Some signs of management experience would be the start of drilling in a relatively new area in 2015, when the industry suffered a significant drop in the price of raw materials. This company demonstrated the profitability of the new area as shown above.
At a time when many managements will pay almost the full price or a small discount to drill very profitable plays, it takes unusual management to find a new very profitable place to produce oil. As a result, shareholders reap the benefits of above-average returns.
The likely result of this is the obvious growth of the current game for as long as possible. But this management is more likely to find another way to grow at low cost if this becomes a priority in the future. The current area is likely to remain occupied for a long time.
In addition, much of Canada consists of stacked oil-containing ranges. There is an excellent possibility that other ranges of this same surface will be viable or competitive with the current range as the 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 a management like this, a company has a bright future ahead. Good management often comes as a surprise. This seems to be one of the best and most experienced managements in the sector.
Small businesses in this industry are often a risky area fraught with fraud, cost overruns, and general ineptitude. That’s why it’s so important to find experienced management who has built and sold companies before. There will be a public record of the past treatment of investors and shareholders that even lenders use before deciding to lend money to new businesses.
Yangarra’s management has indicated its willingness to reduce debt. At some point, management may even decide to pay off the debt in full. This year it seems possible to reduce outstanding debt by at least a third of the current balance. At this point, it will be up to management and its lenders to decide what the desired debt balance is to minimize financial risk in the future.
This was a company that had been acquiring leases and testing different well techniques. The decision to switch to a production company was made just before the coronavirus challenges arrived. This company, fortunately, had fair production to justify reasonable debt ratios given the economic challenges it faced. But the debt market now demands better ratios in the future. Fortunately, there was enough production to sharply reduce debt ratios as commodity prices rose.
This is a company that is likely to solve its debt problems in a year or two. After that, management will decide whether to return more money to shareholders or grow production quickly. Normally, a management that builds and sells companies will choose to encourage the growth of production. This means that this company is unlikely to be an income option for investors (probably never). But the profitability of the well points to a substantial appreciation potential.
Personally, I will normally hold the shares until the management sells the company. I would only sell it myself if the shares were charged a lot with a growth price of several years at the stock price. Right now, the opposite is true. So 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. So it is likely to happen again in the future.