mysticenergy
Overview
Surge Energy (TSX:SGY:CA) is a smaller Canadian oil & natural gas producer, which is guiding for average production around 24,000 boe/d in 2024, following a recent non-core asset sale. That is a slight decrease compared to the average production volume last year of 24,438 boe/d. The liquids percentage has been relatively stable at around 86% over the last couple of years.
Figure 1 – Source: Surge Energy Quarterly Report
The stock price performance of Surge Energy has been relatively poor over the last couple of years, underperforming most peers by a substantial margin. We have seen the oil price decline during this period, so some weakness is understandable. Surge Energy has been disproportionally affected due to a few different reasons, where some of the factors have improved lately, which could cause the share price performance to improve going forward.
- Slightly higher operating costs.
- More financial leverage.
- An increasing share count.
- Lower shareholder distributions.
Figure 2 – Source: Koyfin
Balance Sheet & Capital Allocation
Following the strong oil price in 2022, many producers did at the time deleverage very quickly, and have over the last couple of years started to distribute substantial amounts of free cash flow to shareholders.
Figure 3 – Source: Koyfin
Surge Energy completed a C$202M acquisition in the end of 2022, which caused the financial leverage to increase at the time. So, the company has over the last couple of years had more financial leverage and lower shareholder distributions than many of its peers, which has likely been a headwind for the share price.
The company has been focused on deleveraging and did a few weeks ago announce that it has now reached its C$250M net debt target. Going forward, Surge Energy is committed to distributing 50% of excess free cash flow after the base dividend to shareholders and the remaining 50% will go towards deleveraging. Given that the company will from the August dividend payout have a dividend yield of 7.4%, with monthly payments, the shareholder distributions are now very competitive.
Figure 4 – Source: Surge Energy Corporate Presentation
Operating History & Costs
Since 2017, Surge Energy has seen the production in boe/d grow by 61%, which is a decent number, but nothing spectacular over seven years. The production growth per share is, however, anything but good during the same period, at negative 54%. While most of the dilution happened a while back now, at least I am always somewhat skeptical about a company when seeing figures like these.
Figure 5 – Source: Surge Energy Annual Reports
Over the last couple of years, the realized sales price has declined substantially for Surge Energy and energy companies in general. The realized price was C$69.8/boe in Q1 2024 and the adjusted netback was around C$33-34/boe, which were decent figures.
However, as the second chart below illustrates, operating costs are higher and adjusted netback is lower compared to some of its peers, where several of them have comparable liquids percentages. So, the slightly higher operating costs are certainly something to be aware of with Surge Energy if we see a pullback in energy prices.
Figure 6 – Source: Surge Energy Quarterly Reports
Figure 7 – Source: Quarterly Reports
Valuation
Surge Energy revised its production guidance from 25,000 boe/d to 24,000 boe/d in late May following the sale of some non-core assets. The company also provided an updated capital budget for 2024, with some other minor adjustments.
The estimated free cash flow for 2024, with a WTI price of $75/bbl, is C$100M. That translates to a free cash flow yield of 14% using the market cap of the company and 10% using the enterprise value.
Figure 8 – Source: Company Estimates
Conclusion
Surge Energy has underperformed over a few time periods historically, both operationally and in terms of the share price performance. However, the company does look better positioned now, where the 2024 exit net debt to 2024 operating cash flow is expected to have come down to 0.7.
The valuation is attractive with a free cash flow yield of 14%, using a somewhat conservative oil price assumption. The shareholder distributions are now very competitive with around 75% of the free cash flow going to shareholders and the remaining part to deleverage further.
It is however worth remembering that Surge Energy has somewhat higher operating costs than many of its peers. So, the downside is likely more substantial. I am always a little bit skeptical about smaller companies that are willing to operate with more financial leverage, even if that has improved lately.
Surge Energy is probably a good bet for anyone that have higher oil prices as their base case. If we see a period of higher oil prices, I expect Surge Energy to do very well given the improved balance sheet and higher shareholder distributions. I am neutral on the stock, though, as comparable valuations are available for companies with either lower operating costs or more consistent operating histories.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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