Gran Tierra Energy Stock Goes For A Grand Swoon (NYSEMKT:GTE)


Those investors with long memories will remember that Gran Tierra (GTE) acquired Petroamerica (OTCPK:PTAXF) a few years back in a transaction that many opposed. Gran Tierra got quite a deal. But events conspired to make sure that the surviving company, Gran Tierra, never really was able to demonstrate the advantages of acquiring Petroamerica.

The last three years have actually been so challenging that this company began to increase its debt. That unwise move has also led to a little financial stress in the current downturn. Management mentioned some covenant relief in the announcement about the latest covenant redetermination.

So many times Mr. Market loves the story of “leveraged to the price of oil.” But that leverage often limits options when the markets go south. Leverage often limits management’s ability to “right the ship” even when the problems are not the accomplishment or fault of management.

Source: Seeking Alpha Website November 11, 2020.

The current price is a combination of hostile industry conditions combined with market concern about the debt load. This company clearly does not have the problems that several more troubled companies have that I follow. However, a covenant relaxation should be a warning that the debt issues need to be resolved (probably yesterday). If those debt issues continue to be priorities, then the company could easily head into more serious trouble.

The third-quarter results showed some improvement over the second quarter. The problem is that debt must be serviced no matter how good or bad industry conditions are. Eventually, that debt must be paid even if that day is somewhat in the future. The current price reflects the concerns of the market about the debt. Management has been working to pay down the credit facility.

Mr. Market has long been in the mode to throw out the good and bad oil companies. That happens to be a normal part of the cycle. The quality companies will outperform. Besides, many South American Colombia basins have lower costs than much of the oil and gas industry worldwide. That could allow for a far easier recovery than the market anticipates. So even though this stock has dipped into speculative territory, the situation is far from hopeless.

Source: Gran Tierra Energy September 2020, Corporate Presentation

Also to the credit of management, Gran Tierra entered the current industry downturn with no debt due for a while. The current negative views of the industry may offer management the opportunity from time to time to purchase some debt at a discount to face value. A significant execution of discounted debt purchases may lead to a market re-evaluation of the company.

In the third quarter, the credit facility balance came down to $200 million. But the pace of repayment does not reassure the market. This company needs an oil price rally badly (probably yesterday).

Source: Gran Tierra Energy September 2020, Corporate Presentation

The biggest challenge by far (and the largest risk) is that the company will not be able to get the EBITDA and funds flow from operations shown above to sufficient levels by the time significant amounts of debt comes due. The second quarter is widely expected to be an outlier. However, the second half of the year appears to be guided weaker than expected.

Even in the third quarter the funds flow remained at a dismal $8 million level. But that debt was incurred during far better times. The balance sheet is now a far cry from where it was when Petroamerica was acquired. At this point any new guidance is close to useless until oil prices improve materially.

Currently the key debt ratio using the guidance shown above (and annualizing that guidance) is well beyond 5. Most lending guidelines suggest a debt ratio of 3 or less with something between 1 and 2 being the preferred ratio.

Source: Gran Tierra Energy September 2020, Corporate Presentation

(Note that in the company presentation, the Trailing Twelve Month Adjusted EBITDA should be positive.)

This is a company that had acceptable ratios before the current crisis began. But many managements do not consider just how badly things can go in an unforeseen downturn. The results are that the current quarters are causing some concern in the market about debt repayments far into the future. That is a typical “bottom of the market” attitude.

This coronavirus demand destruction should fade into the past with enough time left to allow for a smooth refinancing of the nearest debt due. Furthermore Colombia has some of the lowest cost basins in the industry. That should allow for a production recovery before many competitive basins.

Source: Gran Tierra Energy September 2020, Corporate Presentation

The “cash flow positive note” shown above is important as this will allow drilling to increase production at some fairly low oil price levels. That low breakeven gives a debt-laden company like this one a possible avenue to grow cash flow enough to service production while much of the industry awaits higher oil prices.

Much of the industry has also been cutting costs. Gran Tierra is also reporting lower costs. That will continue to maintain or increase the cost advantage when compared to much of the industry. These low costs enable production to resume at lower levels and a growth budget to be similarly implemented at lower levels.

The government of Colombia in South America is supportive of the oil and gas industry. This government is remarkably stable. However, there is guerilla activity near the Venezuelan border and blockades or other work stoppages have occurred that had nothing to do with the oil and gas industry. Overall, the industry has one of the better environments in the world.

Conclusion

This company has several ways to make that debt structure far more reasonable in the future.

Source: Gran Tierra Energy September 2020, Corporate Presentation

Much of the industry has been reducing operating costs at a frantic pace. Clearly, this company is getting its fair share of cost reductions. Now a likely oil price rally over the next two years or so should help financial matters considerably.

Probably the largest challenge is that the tendency of management to add debt rather than sell shares to raise capital has caused some unnecessary financial risks during this second major industry crisis in the last 20 years. Hopefully, management will learn the lesson that debt just does not work very well in the upstream part of the industry. The industry conditions are simply too volatile with low visibility for long-term debt to be a viable solution. The company would really need some diversification in order to justify the amount of long-term debt on the balance sheet.

Therefore, management needs to demonstrate a new attitude towards debt aversion in the future. In the meantime, there are several competitors in Colombia that are not as leveraged as this company. Therefore, the current industry uncertainties are not nearly as threatening as they are to this company. So for the time being, this company may be too risky for many types of investors. It is true that should a strong and sustained oil price rally occur in the future, this common stock would provide quite a return. However, timing is very important to a high debt company and the correct timing (as well as strength and duration) is far from assured.

Gran Tierra will likely survive but there are better candidates out there to handle the current unknowns.

I analyze oil and gas companies like Gran Tierra Energy and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies – the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

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