Bonterra Energy: A Sustainable Dividend in 2013

Bonterra Energy is a light oil focused dividend paying intermediate producer that recently executed a transformational transaction by acquiring Spartan Oil. The acquisition bumped the drilling inventory to over 600 net drilling locations across 194 net sections of land prospective for Cardium oil. The announcement also included an increase to the dividend which sounds unbelievable in this environment of price discounts and pipeline constraints. What is the 2013 dividend sustainability outlook pro-forma Spartan Oil’s acquisition? Let’s take a look.

While the acquisition is accretive to Bonterra, Spartan’s shareholders in my opinion got a better deal than the Pinecrest offer. They are getting a piece of a company with a relatively low share count – a little over 30 million shares pro-forma. The new company is guiding for an average annual production of 12,000 boepd weighted 77% to oil and liquids. The best part of it all is that the monthly dividend will be bumped from $0.26 to $0.28 starting in March of 2013.

How many oil and gas companies in Western Canada can afford an increase to their dividend in this risk off pipeline constrained environment? Hardly any, but Bonterra BNE.TO 51.125 [+0.265] enjoys a track record of dividend increases since 2009. The assets they picked up from Spartan are complementary and add to their large inventory of low-risk repeatable Cardium drilling prospects.

Complementary land base – (click to enlarge)

The new annual dividend of $3.36 per share yields approximately 7.5%.  Besides the risk of widening differentials or a drop in the price of oil, I would add the risk of drilling wells in the halo regions (the edge of the Cardium) that would not meet the expected type curve.

For 2013, the company based its guidance on the following commodity price deck:

• $81.88 average realized oil price
• $3.54/mcf AECO average realized natural gas price

Unfortunately, the natural gas price scenario doesn’t look like it will materialize in 2013. Notice how the price of natural gas weighted stocks has been breaking down. On the other hand, the company did not go overboard with its projection as it is accounting for $0.24 in quality adjustment.

Based on company guidance the basic payout ratio comes out to 53% and the total payout ratio falls right in line at 100%. Thanks to a great balance sheet with debt to cash flow at less than 1.0x, this is one of a few energy companies that can afford its dividend. Bonterra does not offer a DRIP program and at least on paper, it doesn’t need to recycle shareholder money to fund its capex or dividend payments.

The worst case scenario in our table above is based on $78 oil and $3.00/mcf gas resulting in a deficit of about $14 million. The figure can easily be absorbed and results in a minor bump in the debt to CF ratio to 1.1x. The balance sheet would still be considered in good shape, it would take a substantial drop in the price of oil to hurt the total payout ratio.

When it comes to the price of oil, you need to remember that the budgeted $81.88 per barrel CAD is equivalent to $90 WTI. This clearly implies a discount of about 9% for Canadian light oil that many E&Ps are modelling for 2013.  The current price for Edmonton light is above $85 which in theory puts the total payout ratio solidly in the green. However, the year is still in its infancy, it all comes down to the average realized price for the year.

I did not find any mention of production hedging, so the oil is pretty much at the mercy of market volatility. If the price of oil rises or if discounts in Canadian prices shrink, the $85 per barrel/$3.00/mcf gas scenario results in a 98% total payout ratio with a surplus of about $5 million. While the oil and gas sector remains out of favor, I believe there’s a limited downside to the share price of BNE  unless we witness a dramatic drop in the price of oil.

The company has also inherited Bakken and Mississippian opportunities from Spartan’s acquisition. Spartan Oil had 77 net sections of undeveloped land in Saskatchewan. While the acreage is exploratory in nature, increasing industry activity in the vicinity will indirectly derisk this land. These assets can be left for future development or sold with proceeds used to strengthen the balance sheet if needed.

Bonterra is one of the best pure-play Cardium companies thanks to its wealth of experience and its quality asset base in the heart of the Pembina area. It has been in operation for years in the same core area. An ex-royalty trust, it has been successful at growing production and its distribution following its conversion to a corporation. That’s unlike many legacy ex-trusts with stock prices currently languishing at record low prices and reduced distributions.

What do you think of Bonterra Energy?