Whitecap Energy (TSX: WCP) yesterday announced a $1.9 billion cash ($1.7 billion net of working capital) acquisition of XTO Energy’s Canadian operations, which involves a huge chunk of land and operating assets in the northwestern portion of Alberta, in addition to a gas processing plant. This deal is much more gas-weighted than liquid-weighted.
This deal works for Whitecap if we are in a “higher for longer” commodity price environment. They are acquiring an immediate 32 kboe/d asset at a relatively expensive price, but the lands they are acquiring have very good expansion potential, which they are targeting in 2023. In 2023, they intend to ramping up Capex from $600 million to approximately $1 billion, which means that they will be generating less free cash flow that year than they otherwise would have had they not made this acquisition. However, that would pay off in 2024 and beyond (perhaps when TMX is actually finished, and the SPR drawdown concludes and thus the WCS differential closes???)
However, this flies in the face of the general thesis for most oil and gas companies that they are generally in “maintenance” mode and they will be distributing the bulk of their cash flows to shareholders. In this particular case, Whitecap will be busy paying off the debt from the acquisition and will need the better part of 2023 to get back down to their end of Q1-2022 debt level ($1.07 billion). Specifically they will not be in the open market buying back stock over the next year. They do provide some clear milestones for shareholder returns (at a $1.8 billion debt, they will increase their dividend and at $1.3 billion, they will increase it to a projected 73 cents/share/year – projected at Q2-2023) – which would put them at an approximate 8% yield.
There is now a clear differentiation between companies that are in maintenance mode (spend the capital to maintain production, and then pay down debt and distribute proceeds to shareholders) and expansion mode. WCP is now clearly in the latter category. It works until the commodity price environment goes adverse.
The market has also soured on the deal – Whitecap traded down 6% for the day after trading initially higher. This is probably going to be a disincentive for other companies contemplating expansionary policies.
That said, if the “higher for longer” environment continues, the stock is looking cheap, along with the rest of the sector. But there is this ominous feel of the winds of recession coming, coupled with the potential end of the cycle of the industry.
In terms of valuations, it increasingly looks like that free cash flow multiples aren’t going to get much higher than present values, which suggests that the mechanism of returns for these companies will be in the form of total returns (the cash they will distribute to shareholders, coupled with the impact of open market buyback operations). It will also be very rocky.
The nature of risk has finally returned into the fossil fuel market.
I think “runoff mode” is better terminology than “maintenance mode”. There seem to be two camps related to O&G. Camp 1 believes that world will come to its senses and ultimately abandon efforts to reduce fossil fuels (too economically painful, climate change alarmism will die out, etc). Camp 2 believes that efforts to phase out/dramatically reduce fossil fuels need to and will continue – only the speed of change is unknown.
The Camp 2 scenario firmly places O&G firms in runoff mode (maybe decades long, but still). Companies in runoff mode have certain characteristics: war on cost (esp. people), returns to shareholders are paramount, capital budgets are minimal, etc. A well-managed company in run-off mode does not do what Whitecap did. They wait for pain (e.g. $60 oil) to take out the losers, only growing the production basis at very low cost.
I’m a Camp 2 person and therefore sold out of any producers at the moment. I was too early of course. I’ll be back buying during the next pain cycle.
Hi,
in terms of future supply there is no difference between Whitecap buying back its own stock and aquring (consolidating) another player – in aggregate there is not much more capex for the industriy.. It does not necessarily violate the “shareholders get the money backW thesis (it is just not Whitecaps shareholderst that get the money)
Eyeballig your figures the economics – in terms of FCF -are roughly the same (between aquiring and buying back stock)
Yes, from a balance sheet perspective ist is much more risky akin to a massive debt funded buyback, but cannot this risk be mitigated by hedging part of future production (at strip prices this should still be comfortably double digit FCS – easy above capital costs).
In case Whitecap is more diversified than before – I am no expert to judge this – and if you assume that fossil fuels will be around for a while, the consolidation can still make sense – although I would have preferred to see some buyback dividend increase..
The FCF did take a hit due to the acquisition – they’re planning on dumping a lot more capex post-acquisition simply because a lot of the Montney land base is undeveloped. It works out if 2024+ we are still in the same commodity price environment (noting that the acquisition was highly gas-weighted). In the immediate term that capex would not have occurred if XTO just let their asset sit, although it can easily be argued another acquirer would have spent the same amount.
Obviously a mining/extraction company cannot go on forever without expanding their reserves, so there are two distinct models of companies out there, those basically on run-off (although the CNQ, CVEs, etc., have gigantic reserve bases) and those in acquisition/expansion. Will be interesting.
Thanx for the reply,
I was somewhat confused by your statement that the aquisition would work only in the current market, i.e. price environment. As I understand FCFs for these projects would be comfortably in the double digits even with WTI around 60-70?
Nevertheless, it probably still was a bad idea, given that the market valuations to not seem to account for reserves in the ground. I do see valuation premia for size or integrated businesses, but reserve life doesn’t seem to be a highly valued factor (“end of fossil”?) – I wonder if you agree with my impression (me beeing new to this market)
It probably would have made more sense to bus one of the smaller, producing businesses for reserve growth, althouhg I do not have looked at the economics of the deal…
In relation to their previous FCF figures, post-acquisition it definitely has increased leverage to WTI prices from the numbers previously projected on their slide deck. They benchmark it to WTI although the XTO acquisition was gas-heavy so I don’t have a good initial read on the sensitivity to AECO/HH.
Right now markets aren’t strongly valuing reserve bases – Vermillion is a good (negative) example of this but the focus might change. I can’t think of any “non-operating but huge land base” type fossil company other than perhaps the royalty companies (but those trade on different metrics).
Just like how 30 years ago few would suspect Berkshire would be trading at $400k/share, same thing goes for how CNQ from 20 years ago to today has become a behemoth, and likewise who knows, maybe WCP will be that story, or maybe they’ll turn into a Penn West and take out 95%+ of their shareholder value!