We already discussed Cardinal Energy (CJ.TO) earlier this year, and were pleased to see the company was still able to produce oil at a very low production cost per barrel. We were looking forward to the company’s performance in the first quarter of 2017 to see if its cash flows remain robust.


Cardinal1 
Source: stockcharts.com

How was Q1?

Cardinal saw its oil-equivalent production rate increase by approximately 6% to almost 15,200 barrel per day. The 6% increase was caused by a 3% increase in the company’s oil production, whilst the gas production rate increased by an impressive 31% thanks to the higher gas production rate from the new acquisition.
Cardinal2 
Source: financial results

The total revenue from oil sales was C$63M, which is almost twice as high as the revenue generated in the very first quarter of last year. The total royalty payment was C$8.7M, but Cardinal also reported a net gain of C$16.7M on its hedging contracts resulting in total revenue of C$70.6M. The pre-tax income came in at C$10.2M whilst Cardinal Energy reported a net income of C$7.6M, or 10 cents per share.

A good achievement, but let’s not forget this was predominantly caused by the gain on the company’s hedging contracts. After all, without the C$16.7M value increase of the derivatives position both the pre-tax and post-tax income would definitely have been negative.

The cash flows remain strong and underpin the capex program

That’s why it’s really important to have a look at the company’s cash flow statements, as it excludes the unrealized income from a hedged oil and gas position. Additionally, it also excludes the (non-cash) depreciation charges which are usually higher than the sustaining capex at oil companies.

Cardinal Energy reported an adjusted operating cash flow of C$15.1M which covered a large part of the C$21M+ capex bill. Indeed, just a large part and not the entire capex, but there’s a very logical explanation for this. Cardinal has already drilled six horizontal wells during the first quarter and whilst these wells are expensive (we’d expect a cost of completion of C$2-3M per horizontal well), this will also start to contribute cash flow from the current quarter on as the production rate will definitely be boosted.
Cardinal3 
Source: financial results

Also keep in mind the acquisition of the new oil project in March only contributed just a few weeks’ worth of gas and oil to the consolidated production mix. Cardinal Energy literally says it’s expecting to ‘report a much stronger Q2’, and we don’t disagree. Whilst the current oil price is relatively low, Cardinal’s basis to continue to increase its production is very sound and further capex investments will only be delayed but definitely not be canceled.

Three wells were drilled at the Mitsue zone and whilst these weren’t included in the Q1 production results, Cardinal has now shared the production results. The first two wells showed a total flow of 533 boe/day and 223 boe/day but the third well was a disappointment with just 50 barrels per day. But there always is a learning curve and Cardinal plans to re-access this specific zone to drill more wells which should now be completed throughout a reservoir.
Cardinal4
Source: company presentation

At the Bantry area, a first well is producing in excess of 500 barrels of oil-equivalent as well, and what’s perhaps even more important is the data inflow which confirms the Bantry wells are still outperforming the reserve estimates and production curves used by the company’s consultants for the year-end report.

Investment thesis

The average production rate was just 15,200 boe/day in the first quarter, but Cardinal has already increased this to 17,000 boe/day thanks to the new wells and the recent acquisition. The operating expenses are expected to drop to just C$20/barrel in the current quarter, so we would expect the higher production rate and lower production cost to make up for the lower oil price.

Cardinal Energy also re-confirmed its dividend policy and continues to pay a monthly dividend of C$0.035. This currently results in a dividend yield of almost 7%. Even at US$45 oil the dividend is safe thanks to Cardinal’s low production costs and its hedge program as 43% of the anticipated production for 2017 has been hedged at almost C$63 per barrel (which is where the hedging gain on the income statement came from).

Disclosure: the author has a long position in Cardinal Energy.

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