Description

All values in C$ unless otherwise stated

Company Description

Canbriam Energy (“Company”) is a private integrated natural gas producer focused on the Montney formation in northeast British Columbia. The Company was formed in 2008 after a management team led by Paul Myers, former CEO of Espirit Energy Trust, secured a US$300mm commitment from Warburg Pincus and ARC Financial Corp. to “pursue the acquisition, exploration and development of oil and gas interests in certain onshore regions of Canada and the United States.” Since 2008, Canbriam has built a significant production, land and infrastructure base.

Investment Thesis

Canbriam’s US$350 million 9.75% 2019 senior unsecured bonds trade at 86 cents on the dollar which equates to a yield-to-maturity of 26%. This less than one-year paper has traded down 14pts on no company specific news and has a limited buyer base due to its Caa1 rating from Moody’s and a CCC- rating from S&P (mandate restrictions). Along with the trading technicals, I believe general negative sentiment towards Canadian energy names and, specifically, Canadian natural gas names, has led to a situation where the baby has been thrown out with the bathwater. There is also a fear that Canbriam will be unable to refinance these bonds come November 2019, but I believe this fear is misplaced as the Company has a number of options at its disposal.

All-Star Sponsors

Canbriam is backed by an all-star group of equity sponsors. The sponsors are:

• Suncor Energy (SU: TSX);
• Warburg Pincus (committed US$10 billion in energy investments since late 1980s);
• ARC Financial (Canada’s largest O&G focused private equity firm having raised $5.8 billion since 1997);
• Ontario Teachers’ Pension Plan;
• State Street Advisors; and
• Blackrock.

Based on various press releases through the years, I estimate that since Canbriam’s founding in 2008, the equity sponsors have provided approximately $1.0 billion of equity capital. Importantly, Canbriam’s sponsors provided $100mm of equity (likely on a prorata basis) in June 2017 - prior to Suncor joining the sponsor group. To my knowledge, none of the sponsors have ever taken out capital.

To put this equity amount into context, Canbriam has $542 million of debt outstanding (assuming $80mm drawn on the credit facility per Moody’s) – with the majority of the outstanding debt being the 9.75% 2019 senior unsecured bonds.

Source: Company Reports

Suncor Energy, one of the largest energy producers in Canada, joined the sponsorship group in February 2018. Suncor vended in 123,000 acres of mineral land holdings in northeast British Columbia and $52 million in cash for a 37% equity interest in Canbriam. In addition, Suncor joined Canbriam’s board with two representatives. Adding Suncor to the mix took the quality of Canbriam’s equity sponsorship group to the next level. Suncor has a market capitalization of $68.7 billion and is rated Baa1/A-.

In its Q1 2018 financials, Suncor recorded the investment in Canbriam at $277 million which implied an equity value to Canbriam of ~$750 million. Utilizing Suncor’s valuation of at 100% of $750mm implies a significant equity cushion below the debt stack. Keep in mind this transaction occurred only eight months ago.

Source: Suncor Q1 2018 Report

The key takeaway from this section of the report is that the equity sponsors have:

1. Injected meaningful equity dollars into Canbriam through the years;
2. There have been equity injections post the energy market downturn in 2014; and
3. One of the largest and most respected oil and gas producers in Canada has become the largest equity owner in the last few months and has two board representatives.

Should Canbriam require additional equity capital in order to reduce the refinancing burden in 2019, I believe the sponsors have the capability and willingness to cut a cheque.

Infrastructure Ownership

While it is unusual for U.S. E&Ps to own and operate their infrastructure, many Canadian producers, including Canbriam do so. Canbriam’s Altares facility has completed Phase 1 and Phase 2 for 160 MMcf/d of processing capacity (in addition to the b-24-H capacity of 50MMcf/d). Moreover, Phase 3 with 120 MMcf/d of additional processing capacity was sanctioned with an analyst estimating $60 million of capital having been spent on the associated equipment.

Source: November 2018 Company Presentation

Source: November 2018 Company Presentation

Although Canadian producers prefer to own their infrastructure, producers have shown an increasing willingness to part ways with the assets in order to reduce leverage. The below table highlights some transaction in Canada whereby gas-focused producers sold assets to infrastructure operators with lower costs of capital. I would argue that the Black Swan transaction might be the most comparable transaction given its recency, Black Swan’s core operating base (northeast British Columbia – same as Canbriam) and the fact that Warburg Pincus is also one of Black Swan’s lead equity sponsors.

Source: Company Reports and Author’s Estimates

Using a range of valuations, I estimate Canbriam’s infrastructure is worth $310 million to $754 million. The Black Swan transaction metric values Canbriam’s infrastructure at $492 million which almost covers Canbriam’s debt outstanding alone.

Source: Company Reports and Author’s Estimates

Non-Core Asset Sales

On July 31, 2018, Canbriam announced that it had divested “some non-core” lands for proceeds of $50 million. The proceeds were likely utilized to reduce amounts outstanding on the Company’s credit facility.

Source: Canbriam July 31, 2018 Press Release

Canbriam has significant land reserves decades of inventory (~29 years of 2P reserves assuming 40,000 boe/d of production). Based on December 31, 2017 reserve assessment, Canbriam has proved developed reserves of $712 million and 2P reserves of $2.49 billion.

Source: November 2018 Company Presentation

With all the land they will ever need and significant production reserves, I believe Canbriam has the ability to sell additional non-core land (without impacting future growth) and use the proceeds to further delever the balance sheet.

The Sky Is Not Falling for Canbriam

Many investors look at natural gas prices in Canada (at various hubs) and wonder how gas producers make money – particularly in environments were AECO, for example, trades at a negative value. A misunderstood part of the story is that certain gas companies produce significant liquids (condensate and natural gas liquids). These liquids components garner premier pricing Western Canada and comprise over half of Canbriam’s revenues (despite only comprising 15% of volumes).

Source: November 2018 Company Presentation

Source: November 2018 Company Presentation

Source: November 2018 Company Presentation

Source: November 2018 Company Presentation

Prior to Q3 2018, Canbriam was guiding towards 37,000-39,000 boe/d of production for 2018. However, after the Enbridge T South pipeline incident on October 9, 2018, Canbriam has decided to voluntarily reduce Q4 2018 production to 26,000 boe/d mostly through minimizing Station 2 exposure (the weakest hub pricing). As a result, 2018 production guidance was updated to 34,000-35,000 boe/d. I believe production in 2019 will return to previous 2018 guidance levels as the Enbridge issue is resolved.

Per the November 2018 public presentation, the majority of Canbriam’s natural gas production is hedged for 2019 at ~$1.57 per GJ. If I assume Q3 2018 realized pricing carries forward into 2019, I estimate Canbriam can generate $135 million of EBITDA. Even if I assume natural gas realized pricing falls to $1.00 per mcf, I estimate Canbriam’s EBITDA would still be $95 million.

Source: November 2018 Presentation

Using $136 million of EBITDA, I estimate 2019 leverage through the senior unsecured bonds will be 4.0x. At 86 cents on the dollar, the Company is being created at 3.5x. This leverage level is not debilitating by any means. Furthermore, I believe, at the right coupon, the 9.75% 2019 bonds can be refinanced with 4.0x leverage.

Conclusion

I believe Canbriam 9.75% 2019 bonds at ~86 (YTM = 27.9%) represents compelling value. The price and yield imply distress, but the Company itself is strong. I believe the underlying assets (infrastructure, reserves, non-core lands) easily cover the bonds and the Company has numerous ways in which to refinance these bonds. Most importantly, Canbriam has an all-star equity sponsor base who have put in $1.0 billion of equity capital into the business with Suncor taking a 37% equity interest earlier this year. These equity sponsors have the means (and based on recent history – the willingness) to inject additional capital into Canbriam if required.

I recommend buying Canbriam 9.75% 2019 at current levels.

Catalyst

• Realization of substantial hedges in 2019
• Non-core asset sales
• Equity injection from equity sponsors
• Successful refinancing