The recent bounce in oil prices has opened the “equity window” for energy companies to raise capital. It’s the first time this window has opened since October. But should investors be buying?
In the last three weeks, three Canadian energy companies raised equity capital; two juniors in Rock Energy (RE-TSX) and Crew Energy (CR-TSX) and most recently a senior; Cenovus Energy (CVE-TSX). All three companies elected to do this at close to their 52 week low.
Investors need to understand the motivation for financing in this low price environment–is it to be a better predator–have cash to buy cheaper rivals who falter–or to better keep the financial wolves at bay by simply reducing your debt line. If it’s the latter, it’s may not be an equity issue in which you want to participate.
Part of the “art” of management is being able to finance near the top of the market—yet still keep your underwriters and new shareholders happy.
When financing now–does management believe that the market still has another leg down, so in a few more months this will look like a good move? Are these companies getting a jump on their peers and building up the “war chest” for when there are some potential deals to be had should a competitor falter?
Or is it an act of desperation because the company knows that when their updated reserve report comes out they will be losing some of their bank line or worse, be in violation of the covenants of their debt.
If we look back to the beginning of January, ARC Resources (ARX-TSX) surprised the market by raising approximately C$400 million through a bought deal. A bought deal is where the underwriters of the equity issue (in this case a consortium led by RBC Capital Markets) take on the risk of selling the stock, so ARC is guaranteed to raise the full amount of money.
A quick look at ARC’s year end results and it’s easy to see that they were being opportunistic.
They added 6% to their year-over -year 2P reserves, which suggests it’s unlikely they will see any change to their $2.2 billion credit facility, of which only $1.1 billion was drawn at year end.
And it appears that they should be able to fund the 2015 Capex program of $750 million from existing cash flow—depending on what the commodity price roller coaster does.
All this includes maintaining their monthly dividend of $0.10/share giving shareholders a 4.8% yield. ARC looks ready to take advantage of any sign of weakness amongst their peer group.
Then Raging River, arguably the leading Canadian oil junior, also surprised the Market with an equity raise. Neil Roszell’s team was likely the only junior Canadian producer who had enough Market respect to do that in early January.
I think those two deals got the investment bankers back to their phones. Rock Energy–all oil–announced an equity issue of C$10 million the first week of February–and investor demand was strong enough they boosted it to $13 million. Looking back at their Q3/14 results, Q4 guidance showed plans to outspend cash flow by roughly $25 million and take their bank line up to $63-$65 million against a total of $80 million available.
That was based on a Q4 average WTI price of US$80/bbl and an exchange rate of $1.13 CDN/US. Although the Canadian dollar weakened versus its US counterpart, it was not by enough to offset the Q4 decline in WTI relative to US$80/bbl. So unless Rock reigned in its Q4 capital program versus the guidance it gave at the end of Q3, it’s likely that the company outspent Q4 cash flow by more than originally forecast and is getting very close to the limit of its available debt of $80 million.
The company has yet to announce it’s 2014 reserves or it’s year end results so we’ll have to see where things stand as far as financially flexibility go, but it appears that the C$10 million capital issuance was a necessary step in being fiscally prudent, and saving the balance sheet.
Crew Energy announced a C$100 million bought deal on Feb 9th. Again looking back to Q3/14 results, Crew had sold some assets, and as a result had nothing drawn on its C$250 million bank line. The company does have $150 million in senior notes outstanding but this isn’t due until October, 2020.
So depending on how aggressive the company spent capital in Q4 relative to cash flow, it would appear that the company is in pretty good financial shape. Proven reserves will likely have fallen a bit due to asset sales, despite growth in each of Crew’s remaining core locations although 2P reserves have increased relative to 2013. So their recent share issue could be getting ready to ramp up organic drilling with better energy prices, or for M&A if the price is right.
Most recently Cenovus Energy came to the market with a whopping C$1.5 billion bought deal. The issue will add almost 9% to the total shares Cenovus has issued and outstanding. It was “priced to sell” as the issue was priced at 4.5% below the previous closing price for the stock.
Cenovus’ future growth is largely coming from oilsands projects—SAGD or Steam Assisted Gravity Drainage, where two big heated pipes get stuck in the bitumen. These projects need a lot of capital up front—billions. But cash flow doesn’t start for a few years. In 3-5 years from now when this wonderful long reserve life, low decline production is on stream—likely at higher netbacks (profit per barrel) than today—the market may shrug this move off or possibly even praise it.
However, the cynic in me thinks this looks like an excuse to maintain the “sacred” dividend because the company fears that the stock might have fallen even further if they cut it.
I’m not sure I can explain to my readers the logic of paying a dividend when current cash flow won’t cover the approved capital program, forcing the company to go raise equity capital at a discounted price.
The market will decide whether the decision to tap the capital markets at these currently low equity prices was a good move or not. Pay particular attention to the Cenovus issue which includes a 10.125 million share over allotment option which gives the underwriters a 30 day option to increase the issue (and collect more fees!!).
If this over allotment option doesn’t get exercised, (feedback is that the underwriters are struggling to sell the original 67.5 million share issue) then it is a sign that investors don’t necessarily think it was the right move.
These financings are clear commodity bets. If energy prices have put in a bottom and slowly but steadily rally from these levels, the market will second guess the decision to dilute the stock at these prices. However, if prices remain flat or even test a lower threshold then these companies will look like heroes in the eyes of their shareholders.
It is a risky move to make and only time will tell if the bet will pay off. Will these companies be able to take advantage of some fire-sale assets, or be the first out of the starting gate when the rig count starts climbing again. Or have they just bought themselves more time to keep the financial wolves away from the door?
As investors, it’s your job to not just take management or analysts at their word but look at a bigger picture to see what the motivation for financings are in this new environment.
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Keith Schaefer
