Description

Obsidian Energy  Ticker OBE.TO (Canada) or OBELF on Pink Sheets

All numbers are in CAD unless noted (then in USD)

Market Cap:  61MM

Debt: 458MM

OBE is a levered Canadian Energy Micro-Cap.  Given the small market capitalization, low amount of trading volume, significant risk of a zero – this name can only be for personal accounts and sized as an option (due to the leverage). 

In addition the stock has more than doubled recently given the move in oil. 

Executive Summary:

Obsidian Energy (OBE – Formerly known as Penn West) has been a horrible investment across all energy markets.  It has performed poorly in rising oil prices, declining oil prices and in stable oil prices.  In 2006 the stock was over $300 per share and in 2016 the stock was over $60 versus sub $ 1 today.  The company’s production has declined dramatically over the last 5 years as well due to asset sales and production decline.  It was a high cost operator with a bad business model (income trust).

While the historical information regarding OBE is quite poor - as highlighted above – under the hood over the last 2 years the company has made some good progress which, with a little bit of luck on oil prices, could prevent a donut.  The old CEO was removed 18 months ago along with adding a few new board members.  The company has become much more competitive on operating costs (including G&A) over the last few years and has become more focused on its Cardium play which appears to be a low cost light oil play.

Due to the low oil prices and leverage OBE is not in a wonderful position.  However, they have proposed a merger of equals with another levered player in the Cardium (BNE.TO) – and if this merger goes through the combined company (after synergies) will have a lower break-even oil price and a fighting chance to survive.  In the scenario the company survives and oil prices rise to $50 USD and CAD natural gas is $2.50 CAD the stock could be a multi-bagger over time.    

Combined OBE and BNE have a market cap of approximately $120mm and Net Debt of ~$800mm.  The expected synergies over 3 years is $100mm - capitalizing 30mm of annual synergies at 4x multiple alone provides a significant uplift in valuation – and allows for the positive loop of increased drilling.

OBE and BNE are like two drunks at a bar.  Individually neither will be able to stand in my view.  Using each other for support gives them a fighting chance to survive.

If the market believes these companies can survive and generate FCF to pay down debt – the increased size can lead to increased investor awareness in the years ahead. 

I believe the risk/reward of OBE is attractive given the set-up with the caveats highlighted above. 

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Summary of OBE and positive changes made over the last 18 months:

1)      Market Cap of $60mm. Net Debt of $458mm.  1H2020 production of 26.500 bbl/day with 2/3 being liquids (Oil, NGL)

2)      Fund Flows from Ops as 12 months of $145mm.  Net Debt of 3.5x

3)      3 main areas of production – Cardium (only real area of focus now), Peace River (Heavy Oil Asset owned in JV with Chinese, zero capital being deployed now, impossible to sell due to Chinese JV), Alberta Viking (okay asset but not worth growing)

4)      In March 2019 the company replaced David French with Michael Faust.  This was long overdue.  French was a bad CEO.  Poor ability to control costs and poor decision making on areas to focus the company on.  As an aside, he was able to BK his next company within 15 months of taking the CEO job. 

5)      Faust was able in 2019 to significantly cut costs and improve the company efficiency.  It had taken some time to play out.  But Opex + G&A went from $18 per bbl in 2017 to around $12 in 1H2020.  In addition Cap Ex costs for wells has declined by 10% since 2H2018.

6)      Most importantly Faust and the new BOD were able to focus the company Cap Ex on the right plays and have high performing wells.  4 of OBE wells were in the top performing wells in Spring 2020.  The company also started hedging better compared to the panic hedges French put on when he was CEO.

7)      After the operational improvements were done, Faust stepped down (but remained on the BOD and is heavily involved).  The interim CEO is a hedge fund guy Steve Loukas.  His firm owns a significant stake in OBE and it has not been a good investment (to be kind).  One of the HF partners father was the chairman of Penn West so the HF has some history with the company.

8)      Steve Loukas is not an oil guy but he was the right person for the job at the time.  The company had 3 main issues – all financial in early 2020.  First, the company was saddled with a high cost office lease from back when the company was bigger.  This lease was for $18mm a year (NET) – but had significant liability due to $33MM of gross rent per year (the difference was subleases).   The company was able to negotiate the lease down to $10mm per year (until Jan 2025 when it expires) – and remove the sublease liability.  Loukas was able to do this with help from the banks and threatening BK to landlord.  Very positive.   Second, the company had notes maturing in 2020 that could not be re-financed given market.  He (again with the help of the banks) was able to get the noteholders to extend the maturity date to late 2021.  Lastly the company needed to extend their credit facility and they were able to do this as well.

9)      OBE lowered breakeven oil price to $45 (keeping production constant, reasonable assumption on NG price).  They claim it’s lower – but given its history I add $5 wiggle room

10)   OBE has done a very good job reducing ARO expenses – both absolute dollars and specific costs.  But the ARO liability is a negative for the company – although not as bad as the market believes.  The Canadian govt is helping with ARO.

OBE Cardium Asset

This is the real decent asset that OBE owns.   Since 2018 production has grown over 20% (and liquids growth of 25%).  It is a short cycle asset.  The best part of Cardium is their Wilesden Green (WG) asset which they are focused on.  Operating costs are around $5 per BBL.  It’s a decent asset.

WG has over 100 type curve locations and the company has a nice runway for growth.  As with most energy companies the highlighted IRRs are great – ranging from 118% to 90% with $50 USD WTI $6 USD differentials, $2.25 CAD Nat Gas price.  Payout is approximately 1 year.   Like many energy companies, these wonderful IRRs never actual lead to positive cashflow.

The other part of Cardium is Pembina.  They have over 800 locations there.  These are not as “good” as WG but given the number of locations provides a decent growth in a couple of years as WG wells start running out. 

The company reserve reports seem pretty conservative.  They have 135 wells booked (out of 900 identified).  The EUR assumed seems reasonable.  I am not a reserve engineer so please don’t take this as Gospel. 

The merger opportunity

OBE has proposed a merger with BNE – where it’s 2 shares of OBE for each share of BNE. The merged company would be essentially owned 50/50.  BNE hasn’t agreed to this deal.  OBE will attempt to tender.  My hope is that the companies will agree to a deal as it’s very compelling.  However until recently the spread was negative so it was a take-under.  It’s finally at parity.

BNE has a market cap of $57mm and net debt of $295mm.  It used to pay a great dividend (now cut).  It has an old CEO who is attached to the company.  It is also very levered.  It has low decline assets in Cardium (Pembina).  It produces 11k of bbl/day (2/3 liquid also).

BNE bankers have them on a tight leash just like OBE. The banks essentially own these companies (combined 800mm debt, 115mm market cap).  I hope they see the synergies and the potential to exit this disaster of credits.

BNE has some nice assets as far as I can tell.   They are low decline and low capital intensity assets.  When oil prices are higher than $60 WTI this can mint money. ($40 MM and growing production 5%)

Both companies have tax pools but these have very little value at this point. 

BNE wants to borrow more money to increase drilling and have gotten money from the govt.  They believe that will allow them to grow and generate cashflow.

The combined Company

(assuming merger at current exchange ratio – my assumption is OBE will give a little bit more)

The combined company will have some scale with over 35k bbl/day.  Due to synergies the combined company will have break evens below $40 bbl/day.  OBE claims $37 bbl/day.  This break-even is with very conservative NG prices – which are significantly higher using 2021 strip. 

The combined company will essentially be able to super-charge the WG asset development by using low decline Pembina cash-flow to grow WG. This is half of the synergies in the first year (25MM out of 50mm synergies).   G&A/opex/etc saves about $25mm per year (that’s the $100mm over 3 year of synergies).  I think of this as 25mm x 4 (capitalized) + 25mm to get $125mm of value.  That’s $0.90 per share of value.  Not bad on a sub 90 cent stock.

The company highlights some cash flow scenarios at $50 USD/ $1.95 NG.   Given that 2021 NG CAD is around $2.50 this feels like a reasonable assumption (each 10 cent NG is around 3mm for combined company).   The company models out $3.20 per share CAD end of 2021 if the deal goes thru.  This assumes 4.5x multiple.  At $55 oil they get approximately $5.50 CAD.

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The stock has moved a bit this week but you could see tax loss selling over the remainder of the year to pick the shares up.   Happy to answer any questions in the comments section.   Again I emphasize that this is illiquid so buy it carefully.  This is effectively an option with high risk of a donut so size accordingly.    At ~80 cents CAD it seems to me to be a good risk / reward. 

Catalyst

Closing the merger, realizing synergies

Slight uptick in Oil and Gas prices