Renegade Petroleum’s announcement of conversion to a dividend paying entity sure came as a surprise. The company dumped the high growth model in favor of yield. Renegade can’t be blamed for the move since its track record of growing production met with a yawn from the market. Let’s take a look at the new dividend paying Renegade Petroleum.
Renegade RPL.V 1.31 [+0.06] was last featured back in the summer as a quality junior oil weighted producer with a diversified asset base. Management grew production 84% per share since 2009 yet the share price languished for most of the year. With investors flocking to dividend paying equities, the company threw the towel on growth and executed a complex transformative transaction emerging as a dividend paying entity.
Let them eat cake, or more like, let them get yield!
Dividend paying equities are in style. Investors favor these assets so why not follow in the footsteps of Twin Butte Energy? The junior E&P sector is starving for capital; companies need to raise money at regular intervals before they reach the organic growth milestone where they can grow production from cash flow. It requires several thousand barrels of oil equivalent before that happens but the market is just not helping.
Renegade hit the ground running by purchasing 3,600 boe/d of production 94% weighted to light oil for $405 million. Why wait several quarters to ramp up production through the drill bit, just buy it and set the cruise control on. Proforma, RPL is expected to exit 2012 at 8,000 boe/d with a 95% weighting to light oil
Renegade’s new plan is to pay a sustainable annual dividend of $0.23 while generating 2% growth per year. Management is also planning to protect that dividend by gradually hedging 75% of 2013 and 60% of 2014 production. The company now holds more than 1,000 gross drilling locations targeting low-risk Viking and Mississippian conventional targets in Saskatchewan.
That leaves the company with more than 250 net drilling locations on its Slave Point, Spearfish and Bakken acreage. The Slave Point and Bakken acreage doesn’t quite fit the low risk portfolio so a farmout agreement or an outright sale might be in the cards.
At 8,000 boe/d, the company is guiding for a dividend sustainability ratio of 94%, a great start in my opinion as they are budgeting Edmonton Par at $81.50 per barrel. Contrary to the oil weighted cross border trusts, they don’t have to ramp up production or execute further acquisitions in order to get their sustainability ratio below 100%, they are already there.
RPL is also starting below 100% while budgeting a realistic price of oil for a good reason; their proforma debt will be 1.8x with $80 million left undrawn on their credit line. At 94% all-in payout ratio, they will be free cash flowing about $8 million that would be paid on debt. Their corporate decline rate is 25% which means the company has to replace 2,000 boe/d every year at a cost of $35,000 per boe/d or $70 million.
How does 2013 look like? Well, it all depends on your outlook for the price of light oil. So far, the company only has 1,000 bopd of 2013 oil production hedged at $102/bbl Canadian. How much will the remaining barrels get hedged at? That’s the question. I used my O&G analysis software to build a table that estimates free cash flow which can be paid down on debt and the sustainability ratio based on the realized price of oil.
You can see the company’s budgeted $8M in free cash flow above. If the company’s realized average price of light oil in 2013 is $90 per barrel, the D/CF ratio falls to 1.6x from 1.8x since RPL gets to pay down $28 million on debt. If however, you believe oil is crashing through the floor down to $60 per barrel, stay away as the stock will be abused and the distribution cut (risk is valid until their hedge book is up and running).
The obvious risk for the price of oil will be mitigated once their 75% of production hedges are locked in. Just like Twin Butte’s success story, over time I expect the yield to fall and potentially settle around 7% for a target price of $3.30. That might be a few quarters away as the debt is a little bit high in my opinion.
In the long run, with a growing stream of free cash flow RPL may choose to bump its dividend or simply increase its growth rate. However, in the near term, RPL’s team will have to show the market they are running a well-oiled dividend paying machine. I don’t expect Renegade’s conversion to be the last one in this sector; I think it is only the beginning.
What do you think of RPL’s move?