ARC Resources recently released its Q2 numbers reporting strong operational results. Relative to 2011, quarterly volumes rose 14% year over year for Q2 with oil and natural gas liquids production up 19%. On the other hand, the company’s funds flow dropped 60% during the same period. But despite the drop in cash flow, management believes the dividend is sustainable as a cut would be the last measure to consider if a prolonged period of low commodity prices is experienced. Let’s take a closer look at the company.
ARX’s netbacks were pounded by record low natural gas prices this year realizing $2.03/mcf (before hedging) versus $4.05/mcf a year earlier. The company averaged ~94,500 boepd with oil & liquids volumes accounting for 38% of production and 80% of revenue. YTD average production is ahead of its guidance of 91,000-94,000 boepd for the year thanks in part to incremental volumes resulting from the first full quarter of operations from ARC’s newest gas plant at Ante Creek.
There’s a good reason ARC is raising up to $345 million by selling shares, the dividend is currently not covered by cash flow and the company needs to ensure they can afford to spend a hefty capex of $800 million next year which includes building 2 new 60 million cubic feet per day gas plants in BC. The latest issue is opportunistic given its share price has recovered sharply following PRQ’s takeover by Petronas and preserves its financial strength leaving it with more than $550M to draw on. Let’s take a look at the dividend sustainability ratio:
2012 scenario + price deck:
- Average production: 94,500 boepd (38% liquids)
- Edmonton Par oil price: $83 CAD
- AECO Natural gas: $2.90 /mcf
The price for oil represents the average price realized YTD by the company; it is relatively conservative as it accounts for the risk of volatile differentials between Edmonton Par and WTI prices. Any improvement in Europe or the global economy would certainly contribute to realizing a higher price for oil. The realized price of natural gas is significantly higher than the average YTD price of $2.10/mcf and that’s because the company has 60% of its NG production hedged around $3.25/mcf. Based on the above, my calculations produce a CF netback (profit per barrel) estimate this year of ~$20 per boepd which results in a total payout ratio of about 135% excluding drip.
That’s a deficit of ~$250 million dollars for 2012!
But if we take DRIP proceeds into account, with a ~30% participation level the company recovers $110M which brings the total payout ratio down to ~120%. That’s still a deficit of $140M for this year which can be absorbed through the current credit facilities.
According to management, a dividend cut would be the last measure following deferred capital spending. The active hedging strategy certainly helps mitigate commodity price volatility, the company hedges up to 55% of production 2 years out and a maximum of 25% beyond 2 years. Furthermore, the latest equity issue also improves its financial position keeping debt to CF at 1.4x. Realized natural gas prices will also help since the forward strip is considerably higher in 2013 (>$3/mcf) and thanks to hedges.
I believe ARC’s dividend is safe and the company will survive this challenging commodity environment and move on to prosper in 2014 and beyond. The commodity that has inflicted so much pain on its CF this year will provide ALL the upside once export facilities become operational through its significant Montney natural gas and liquids resource plays in BC and Alberta.
Diversified Asset Base
ARC is the third largest operator in the region with over 400 net sections of land. Just in NE BC, the Montney holds a best estimate of 4.0 TCF and 98MM boe of liquids in contingent resources (quantities estimated to be RECOVERABLE).
Finally, ARC ARX.TO 30.76 [+0.65] isn’t cheap at this price level, the yield at 5.1% pretty much proves it. But it is a well-run company and while it still carries the risk of high exposure to natural gas, it’s quality acreage makes it a take over candidate a la Progress. Excluding a take over scenario, at the current price level, I don’t think this is the hottest stock to hold for capital gains in the short term. The company is currently focused on its oil and liquids rich opportunities and remains a long term call on natural gas paying a dividend to those who have the patience to wait.
What do you think of ARC?
