Description

NuVista energy is a Canadian-listed E&P company which owns acreage in the Montney shale in Alberta.  The company has grown rapidly over the last decade due to its outstanding acreage quality.  Nuvista is a split producer.  Based on forward curves, the company generates roughly 60% of its revenue from oil and 40% from natural gas.  Currently, NuVista is drilling approximately 40 wells per year relative to an inventory base of 1,050 high-quality locations. 

Intro to the Montney Shale 

Canada’s Montney is an underrated shale play.  The chart below measures the tiered quality of remaining inventory for major North American shale basins using a 20:1 WTI to Henry Hub ratio.  Montney’s average location is currently estimated to have a breakeven of $51.19/barrel using a 20:1 ratio.  Enverus estimates that currently the Montney has ~30 years of inventory which breaks even below $50/barrel at the current drilling pace of 928 wells per year.  This is considerably more than either the Delaware or Midland Permian which have roughly 10-15 years of equivalent-quality acreage.  (A breakeven of $60/barrel would mean that futures well generate a 0% ROIC assuming all cash flows generated from that well are discounted back 10% using a WTI price of $60/barrel and a Henry Hub gas price of $3.00/mmbtu). 

Although NuVista is not the largest Montney the company, the company is among the best in terms of acreage quality.  Based on historical well results and the prospective acreage, the company’s average future well breakeven at a 20:1 oil to gas price ratio is $42.60/barrel for oil with $2.13/mmbtu Henry Hub for gas (20:1 price ratio).  To put this into perspective, other Montney producers like CNQ, Petronas, TOU, OVV, COP, Cambrian and Murphy are all above $50/barrel from a breakeven perspective.  There are a few other guys like Strachona that also have sub $45/barrel breakevens, but they their corporate-level returns are weighted down by oil sands.

Right now there is a strange thing going on with Canadian E&P valuations that I can not fully explain.  Companys with oustanding depth like NuVista are not trading at big premiums like their cousins in the lower 48.  The chart below shows the TEV / Current Production Value ratios for various producers.  (Current production value is a reference to the company’s PDP value, which is wells that have already been drilled, at strip pricing). In the lower 48 acreage depth is the most important driver of valuation -- which intuitively makes sense.  In Canada strong acreage depth seems to be free.  

I struggle to explain why this phenomenon currently exists.  Here are a few possible explanations.

1. Right now, the pod shops (P72, Citadel, Millenium) are warehousing by far the best E&P analysts.  As the Montney has been further delineated valuations haven't run up much because those analysts don’t spend much time on the Canadian market.  
2. Many of the Canadian E&Ps are mixed producers, like Nuvista.  Mixed producers are trading at a discount because PMs like to express a view on either gas or oil, rather than both at the same time.  Pureplays get better valuations. 
3. The market is worried that Canada is uniqely unattractive because of political risks or the risks that basis differentials could blow out. 

I'm okay with 1 & 2.  #3 is obviously a concern but I don't see this as a severe near-term risk. 

I appreciate that buying into my thesis requires belief in the acreage depth.  Acreage quality can be difficult to vet without access to a well data scraping service.  However, if you want to gut check how good this E&P, look at NuVista’s historical performance.  Since the end of 2019, Nuvista has done the following:

• Reduced share count by 8%.
• Reduced gross debt by $400mm.
• Increased natural gas production by 54%.
• Increased oil production by 56%.  

It’s tough to find any shale E&P over a 5 year period that has ever done that well.  And it’s not like 2019-2024 was an easy time to be an E&P company. VIC is littered with write-ups on bad E&Ps that are trading at 4x EV/EBITDA.  This is not a bad E&P.  

As for valuation...

Right now, the company needs to spend approximately CAD$ 325mm in annual capex to maintain flat production.  At $75 WTI/$3.50 gas (roughly the forward curve) they generate approximately CAD$ 650mm in EBITDA.  So that’s CAD$ 325mm in OCF against an enterprise value of CAD$ 2.8b.  A 12% OCF yield to the enterprise when an E&P is growing production per share by ~15% is way too cheap.  I think the stock is a double in 2-3 years, but to be conservative I'll set my price target at $20/share CAD. 

I expect to do even better because I think the forward curve on natural gas is too light.  I think Henry Hub is going to $4.75/mmbtu in the out years.

Catalyst

Long-term growth in FCF.