Pipestone Energy: Don’t Extrapolate The Weak First Quarter (OTCMKTS:BKBEF)

Close up of pipe log with red valve in forest

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Introduction

Pipestone Energy (OTCPK:BKBEF) is a producer of natural gas and Natural Gas Liquids in Canada. The Q1 performance was pretty light but investors should be aware this is not representative of the true underlying earnings power.

pipestone price chart
Data by YCharts

Although Pipestone’s US listing is relatively liquid with a few ten thousand shares changing hands on a daily basis, the company’s Canadian listing offers superior trading volumes with an average daily volume of close to 600,000 shares. The ticker symbol on the TSX is PIPE. Throughout this article, I will refer to the company’s Canadian listing and use the Canadian Dollar as base currency.

The results in Q1 were disappointing, mainly due to external factors

The total production rate in the first quartet was just under 27,600 barrels of oil-equivalent per day with very little oil (just a handful of barrels per day) and about 11,800 barrels per day in Natural Gas Liquids. That’s great as the average realized price for these NGLs has almost doubled compared to the average price in the first quarter of last year.

The total revenue in the first quarter increased to C$143M (despite seeing the total amount of royalty payments more than triple due to the higher realized prices) but the net revenue as reported by the company was a less inspiring C$99.2M as it included almost C$44M in realized and unrealized hedging losses.

Income Statement

Pipestone Energy Investor Relations

That’s too bad because it weighs on the results. The total expenses were less than C$60M resulting in an operating income of C$40M and a net income of C$27M despite recording that C$44M in hedging losses. Looking at the per-share performance, a net income of C$27.1M represents an EPS of C$0.14. That’s C$0.56 on an annualized basis. Not bad for a quarter with a disappointing production rate and including in excess of C$30M in unrealized hedging losses.

I think it’s also important to analyze the cash flow statement. Perhaps even more important than only looking at the income statement.

Cash Flow Statement

Pipestone Energy Investor Relations

In the first quarter, the reported operating cash flow was C$64M but this includes a C$22.3M investment in the working capital position and excludes C$1.6M in lease payments. On an adjusted basis, the operating cash flow was C$84.7M. You can also see the total capex was almost C$78M which would indicate Pipestone is only generating C$6.7M in free cash flow (this still includes about C$12.7M in realized hedging losses).

Keep in mind the vast majority of the capex bill is related to additional growth. As you can see, the total capex is more than four times higher than the depreciation and amortization expenses. And as Pipestone is planning on spending C$230M on capex this year, we can definitely say this year’s capital expenditures have been front-loaded. The average capex per quarter for the next few quarters will be just C$50M per quarter.

The guidance for 2022 and 2023 remains very strong

The main reason for the disappointing performance in the first quarter was an outage at Keyera’s Wapiti gas processing plant. The plant was down for 22 days (which is about 25% of the quarter!) and this negatively impacted Pipestone’s production volumes. Since the plant successfully reached full capacity again, Pipestone’s oil-equivalent production rate has increased by about a third to 36,000 boe/day in April. That’s good news, but Pipestone will have to deal with other outages at other plants so it’s Q2 production rate is anticipated to be 30-32,000 boe/day (which would be a 10-15% increase compared to Q1) while the full-year production guidance now comes in at 31-33,000 boe/day.

The disappointing production result in the first quarter will be made up for in the next few quarters and Pipestone Energy is likely still planning on exiting 2022 with a production rate of 37,000 boe/day in the final quarter of the year. That will be necessary to indeed boost the average production rate in 2023 to 40-42,000 boe/day ahead of a subsequent 15% production increase in 2024. In 2024, the exit rate should be 50,000 barrels of oil-equivalent per day.

Long Term Production Growth Plan

Pipestone Energy Investor Relations

The expansion plan seems reasonable. In 2024, Pipestone is aiming to generate C$245M in free cash flow using an AECO gas price of C$4 (the current spot price is approximately C$6.5 and the futures market seems to indicate an average gas price of C$4.5-4.75 for FY 2024, so Pipestone’s expectations are quite realistic.

Assuming the share count will decrease to 250M shares by the end of 2024 including the impact of the convertible preferred shares which can be converted into common shares at C$0.85 free cash flow per share will jump to C$1 which means the stock is currently trading at just under 4 times the anticipated free cash flow. Meanwhile, almost half of the current market cap will be covered by net cash at that point.

Investment thesis

And that makes Pipestone Energy quite attractive at this point. The balance sheet is getting stronger by the day and the already low net debt should be converted into a net cash position by next summer. And if all goes well (read: the AECO natgas price stays above C$4), almost 20% of its current market cap will be backed by net cash by the end of next year.

At this point, Spartan Delta (OTC:DALXF) is my largest position in the Canadian natural gas sector. Pipestone’s land package is literally bordering Spartan Delta and perhaps both companies should consider combining forces. I currently have no position in Pipestone Energy but I am getting increasingly interested after the recent share price correction.

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