Description

Company: Athabasca Oil Corporation

Security: ATHCN 9 â…ž 02/24/22 Bonds at 96 (11.6% YTM)

Company Overview

Athabasca Oil Corporation (ATH CN or the company) is an oil company focused on 1) light oil resources in northwestern Alberta and 2) oil sands (thermal oil, SAGD or heavy oil) in the Athabasca region in northeastern Alberta.

In the Light Oil division, Athabasca has exposure to two plays 1) ~200,000 gross acres prospective for Duvernay at Greater Kaybob and 2) ~65,000 gross acres prospective for Montney at Greater Placid. This division is via a joint venture with Murphy Oil that was signed in May 2016 and will see $1Bn of investment in the Duvernay over four years, of which ATH CN is responsible for $75MM on the first $1bn spent. ATH CN retains a 70% working interest and operatorship in the liquids rich Montney at Placid.

In the Thermal oil division, the Company’s Leismer and Hangingstone assets are low decline conventional oil sands assets that are fully built out and have the ability to generate meaningful free cash flow. The Company has exposure to ~1.1 million barrels of bitumen reserves (proved plus probable) and ~6.5 billion barrels of bitumen resource (best estimate unrisked) with 80,000 bbl/d of regulatory approved low-risk development opportunities.

ATH CN prices its oil off the WCS (Western Canadian Standard) oil benchmark. This often a discount to the WTI standard US oil price due to location and a key risk in addition to oil prices.

All figures in $ are Canadian dollar, unless otherwise indicated.

Investment Thesis / Trade Summary

Recommendation

Buy ATHCN 9 â…ž 02/24/22 Corp (Senior Secured Second Lien Notes) at 96 for a YTM of 11.6%. ATH CN’s $601MM bond ($US450MM) sits above $272MM in cash and an equity cushion/market cap of $480MM of a company that’s projected to generate free cash flow in 2019 of $65-$105MM. In the event of a sharp oil correction, the company has an additional $75MM - $100MM of infrastructure it can sell (which covers interest for over one year).

Source of mispricing 

ATH CN has a very messy recent history. The company grew production in 2017 by acquiring an asset from StatOil and 2018 was impacted by a sizable plant turnaround in H1’18 (i.e. the company shut down the heavy oil plant, which diminished EBITDA), just as Q3’18’s EBITDA hit $76MM (a run rate of $303MM), the oil volatility in Q4’18 resulted in a loss for the quarter.

Valuation & Capital Structure

The bonds are very wide compared to US E&P peers:

Valuation

ATH CN’s bonds are at a 1.4x 2019 net leverage. 

A relevant transaction multiple is the failed acquisition of MEG Energy by Husky Energy. Husky Energy announced a proposal to acquire all outstanding shares of MEG Energy on Sep 18 2018.  The implied total equity consideration was $3.3 bn (37% premium over MEG’s closing price on Sep 28, 18) and implied MEG EV: $6.4 bn (~$3.1 bn of net debt). This created MEG at 7.1x EV/2019 EBITDA, compared to ATH CN bonds at 1.4x 2019 EBITDA.

Husky attempted to buy MEG to fill their significant refining capacity (refining capacity > heavy oil production), pipeline transportation, storage and logistical assets help to shield MEG from location/quality differentials. Husky walked away from the deal though they have gained enough support to win the deal as MEG’s management wanted more money and a greater management golden parachute.

Covenants

ATH CN’s bonds are senior secured second lien notes with no maintenance or financial covenants.

Athabasca may redeem the 2022 Notes at the following specified redemption prices (outside of using asset sale proceeds):

• February 24, 2019 to February 23, 2020 - 104.9% of principal

• February 24, 2020 to February 23, 2021 - 102.5% of principal

• February 24, 2021 to maturity - 100% of principal

Company Details

History

ATH has a tumultuous history as initially one of the largest Canadian IPOs with a large undeveloped resource base and a levered capital structure. Over the past few years, a new management team has transformed and improved the business which had been overlooked by the market. There was a new CEO and a new chairman who joined the company in 2015. They diversified ATH away from entirely heavy oil to light oil as well, entered into a unique JV structure with Murphy Oil to minimize development risk, the JV also gives ATH CN light oil which is a key input to the heavy oil process.

Business

ATH is an intermediate oil weighted producer with a position in three of Alberta’s most active resource plays: the oil sands, Montney and Duvernay. It is organized into a Light Oil Division and a Thermal Oil (heavy oil/ oil sand oil) Division. Current production is roughly 40k barrels of oil per day (90% liquids). ATH also has high torque to the WCS oil price. Segments:

1 ) Thermal Oil

Major project areas are in the Athabasca region of northeastern Alberta and producing properties included Leismier and Hangingstone Projects. ATH has very long-life, low-decline thermal oil assets (80 yr 2P reserve life, minimal sustaining capital $5-$10/bbl. Thermal oil requires a lot of upfront investment but sustaining capital is minimal in the long term.

2 ) Light Oil

ATH’s principal development properties are located in the Greater Placid and Greater Kaybob areas. ATH holds a 70% operated working interest in the Greater Placid area and a 30% non-operated interest in the Greater Kaybob area. ATH’s light oil portfolio has very high margin with top netbacks in its peer group.

Unique Funding

ATH found creative and accretive ways to raise capital. ATH sold a a contingent royalty agreement, raising a total of $400 million of cash proceeds structured with a linear royalty scale. It pays nothing on current oil price. In the current environment, you need a $75 WTI price before the royalty is triggered at 2% and oil price would have to exceed $155 before the full royalty is paid. So far, the royalty has been highly accretive to this company, it hasn’t had to make a single royalty payment and has been able to deploy that cash to grow the business and create value.

Acquisition

Early in 2017, Athabasca acquired the Canadian oil sand assets of Statoil for $550MM (cash $435MM, remainder in stock), the government-controlled Norwegian energy company. ATH acquire these assets through a non-competitive process at a very attractive price as the Norwegian government pressured Statoil to exit Canada. The acquisition was highly accretive to ATH on a cash flow and reserves per share basis. It also delivered ownership of strategic infrastructure assets.

As part of the acquisition, ATH received a $300k barrel tank farm and two pipelines. However, energy stocks are usually screened for and evaluated on a EV/Adjusted CF basis. But this matrics doesn’t account for tangible assets value. ATH received these highly valuable infrastructure assets as part of the acquisition effectively for free, and the fact that they are weren't being reflected in the company's valuation was key.

ATH monetized these assets by the sales of infrastructure assets for $265NN. What was impressive was the fact that within two years, ATH more than payback all the cash proceeds used for the Statoil deal. That was a very effectively transaction for Athabasca.

Sales of Asset

ATH announced the sales of its Leismer pipelines and Cheecham storage terminal to Enbridge in early 2019. Each asset has regulatory approval for 400k bbl/d and a reserve life in excess of 80 years. It was a highly accretive transaction at 10x EBITDA versus 6x the company currently. Key elements of the transaction include:

·       $265 million cash consideration with an annual toll of ~26 million

·   Priority service on pipelines and dilbit/diluent tanks; excess volumes receive a discounted toll

·       Enhanced credit terms with Enbridge across the Thermal Oil business

Leismer’s cost structure will remain competitive with other top tier oil sands projects with a US$43 WTI operating break-even price (assuming a US$18 WCS differential). Future use of proceeds may include debt reduction, growth initiatives or share buybacks. The transaction closed in Jan 2019.

Athabasca acquired the Leismer and Corner assets in early 2017 for cash consideration of $435 million, 100 million of common shares and contingent value payments triggered at oil prices above US$65 WTI (inflated adjusted). In less than two years, the Company has recovered approximately $500 million of its investment through free cash flow generation, the sale of a contingent bitumen royalty and the transaction proceeds.

Historic Financial Review

Summary / Projections

Historic

ATH CN’s historic numbers are a bit messy, presenting the opportunity:

2018

o   Q4’18 – Oil price volatility.

o   Q3’18 – A historic best in terms of EBITDA for the quarter at $76MM ($303MM run rate).

o   H1’18 – Every few years ATH CN has to shut down it’s heavy oil plant for maintenance, this can’t be done in the winter and was completed in Q2’18 after postponing for over a year. When the plant is shut down, there is no heavy oil production, resulting in EBITDA of $40MM for the quarter

2017

o   H1’17 ATH CN closes on the Statoil transaction and the addition of its production, opex is cut post transaction as Statoil had 400+ ppl working on the asset.

Projections

Athabasca is implementing a minimum 2019 capital program with a focus on maintaining base production until market fundamentals improve.

• Preliminary capital guidance of $95 – $110 million

• Production guidance range of 37,500 – 40,000 boe/d (88% liquids)

• WTI is expected to be $60 for 2019, $55 after with a $10 discount to ATH CN’s Canadian location.

• Oil / condensate expected to be at $64.

• Nat gas expected to be $3 and NGLs at $40.  

 1) Light Oil

CAPEX range ~$15 - 30 million net with production guidance between 10k - 11k boe/d (88% liquid)

 2) Thermal Oil

CAPEX estimated at $80 million with production guidance between 27.5k - 29k bbl/d. The Industry Curtailments are not currently included in annual guidance and are expected to be a temporary measure to tighten historically high differentials. Athabasca’s proportional share of the 325,000 bbl/d industry curtailments is estimated at 1.5k – 2k bbl/d on a monthly basis through Q1 2019.

Management / Insider transactions

Source: https://www.canadianinsider.com/company-insider-filings?ticker=ATH

Industry Overview

Canadian Oil Market

Besides the large decline in oil price, Canadian producers have experienced unprecedented differential and basis spread volatility across light and heavy product streams in 2018 due to pipeline capacity constraints. The Alberta Government announced mandatory short-term industry production curtailments starting in January 2019 to alleviate the high differential (called WCS, the price of oil in Canada vs WTI US), a situation expected to last until for 2019. Since then the differential outlook has improved significantly. The differentials are expected to moderate in 2019 supported by the Industry Curtailments (325,000 bbl/d), additional crude by rail (currently ~275,000 bbl/d), the start-up of Northwest Refining’s Sturgeon Refinery (80,000 bbl/d) and the Enbridge Line 3 replacement project in H2 2019 (375,000 bbl/d).

Risks

Oil Price / WCS Differential

o   ATH CN is subject to two bit commodity impacts, 1) is the price of WTI oil and 2) the differential the company receives for its oil vs WTI (i.e. the WCS differential). The below is funds flow (i.e. FCF before capex, after interest costs). The company is profitable at $55/oil and a $15/WCS differential (i.e. $40 oil realized, $55 - $15). If oil is below $50 and the WCS differential is above $15, ATH CN would be free cash flow negative. WCS is currently $48 (USCRWCAS Index), with WTI at $60 this suggests a $12 WCS differential.

o   At the current oil price / WCS differential, net debt to funds flow (free cash flow before capex) is 1.0x-1.7x.  The WCS differential is highly volatile and certainly a risk for ATH CN, mitigated by its strong balance sheet.

Catalyst

A stabilization of oil prices can potentially lead to an early tender of the bonds combined with a refinance.