Eagle Energy Trust’s last Q3 report was below expectations due to operational hiccups. The company reduced its guidance for the second half of 2012 which triggered a drop in the stock price. Its time to check on the dividend sustainability based on the anticipated lower production volumes in 2013.
Q3 production came in at 2,825 boed (98% oil) which was lower than market expectations. Guidance for H2/12 was reduced from 3,600 down to 3,000 boed with an exit rate of 3,300 boed.
What exactly went wrong?
At the Salt Flat field the well type curve calls for an IP (initial production) rate of ~120 boed but a number of wells ended up getting an IP rate of 80 boed which explains the downward revision in production.
Production was curtailed due to the failure to displace well drilling mud. The mud program was modified with the intention to improve results but that didnt work out so well. The company went back to its old drilling practices and recently drilled 4 wells that came on according to type curve well performance. That’s very important as Salt Flat wells enjoy strong capital efficiencies costing about $1.1 million a pop and do not require any fracking.
Eagle EGL-UN.TO 5.63 [+0.09] does not believe the formation was damaged. A clean-up operation was??initiated??in order to remove the garbage from the??under-performing??wells. The company believes this could result with an??up-tick??in production, but this has not been factored into the new guidance.
This means Eagle might recover some of the lost volumes and end up slightly above the new guidance. At first glance, the mud fiasco is now a thing of the past. However, at this point the damage is done and the Market is now in show me mode.
The company remains financially strong and has about 1,300 bopd hedged at ~$95 in 2013.??Even though the company is carrying an annualized debt to cash flow ratio of 1.2x as of Q3, this figure is expected to drop below 1.0x down to 0.7x according to my O&G analysis software in 2013.
Obviously, these operational hiccups have ruined the sustainability ratio for 2012 and 2013. The scenario for 2013 is the following:
- Average annual production of 3,600 boed (98% oil)
- Average realized price of oil at $90 per barrel
- Capital program of $43 million
- DRIP rate of 65%
Natural gas prices are irrelevant in this case; it’s the price of oil that matters. The company sells its oil at a small premium to WTI which is a bonus. Our scenario results in an estimated sustainability ratio of %140 for a deficit of $21 million ‘ ugly. Thanks to a 65% DRIP participation rate, the ratio drops to 105% for a modest $2.5 million deficit that can be easily absorbed by the company. The deficit may turn out to be smaller due to lower drilling & operational costs.
Is the dividend in danger? I don’t think so, not as long as oil prices remain above $80 in my opinion. However, the stocks sensitivity to the price of oil has certainly increased as investors are more cautious. Going forward, I don’t expect much in terms of capital gains until they prove they are out of the woods and improve on their sustainability ratio. The fact that this is the company’s second miss means it will take a few quarters before we see $11 per share again.
The 2013 capital budget will be coming out in a few weeks. I expect the figures will produce similar results to what we have here. Eagle Energy’s operating netbacks exceed $47 per barrel in my scenario their oil is profitable. They need to reassure the market of their ability to meet guidance again. EGL is no longer an overweight position in my portfolio until further notice.??In the long run, those DRIP investors buying shares at a 5% discount every month might end up with a big win on hand in a few years. But I prefer to see a few good quarters before stepping back in for more.
What do you think of EGL.UN going forward?