Baytex Energy (OTCPK:BTEGF) has spent years repairing its debt-laden balance sheet. The executive director who almost completed the task, Ed LaFehr, will retire. New CEO Eric Greager will need to show some continuity from the policies they brought this company came back from a zombie state due to all the debt. That seems to be the way things will at least start. In the long term, the debt ratio must remain conservative so that debt levels are never as threatening in a recession as they were in the past.
Management is on point where share buybacks have started in addition to debt repayments. The earnings report due in a few days will indicate how close the debt levels are to the next step in the diagram. Management wisely based the forecast on debt levels because sales prices are so volatile that it is difficult to forecast free cash flow for a schedule rather than debt level progress.
But the increased flexibility allowed by lower levels of debt has allowed various types of growth to seep into the future despite an initial guidance of hold.
The largest source of short-term earnings growth will be the Clearwater Play. The yields listed above are the highest of all the basins in which the company operates. The only challenge is that heavy oil is a discount product. Therefore, during periods of low commodity prices, the discount can, and usually does, widen to the detriment of heavy oil producers.
Clearwater Play has unusually low break-even points. Therefore, wells in this field should still generate cash flow during a cyclical downturn. However, there are times when heavy oil wells on legacy properties were shut down until prices improved significantly, so the wells were cash flow positive. Therefore, there is likely to be both a demand from lenders and shareholders to balance heavy oil production with lighter oil production to ensure a minimum amount of cash flow during a downturn.
But in the current environment, this project is the most profitable with the fastest returns. Replacing legacy cash flow with cash flow from these wells is likely to substantially improve the company’s profitability while lowering the corporate break-even point.
Lowering the corporate break-even point means more free cash flow at lower commodity prices than in the past. There were years when the material amount of cash flow came from Eagle Ford (before Viking came into the company). Management now has Viking, Eagle Ford and potentially Clearwater to ensure cash flow in times of low prices. That ensures a more comfortable ride in times of harsh industry conditions.
The Eagle Ford is not as profitable as heavy oil in times of strong commodity prices. But the light oil produced is a premium commodity with firmer prices during commodity downturns. Reasonable cash flow from this acreage is assured during times of low commodity prices due to the low break-even point combined with better prices for light oil.
This project has long been an important part of the company’s cash flow. The Eagle Ford project is generally prioritized in capital dollars due to the relatively strong economy during weak commodity prices. These wells are not managed by the company. Therefore, the development of the lease is not under the control of management.
The company has operations at Viking in Canada. This light oil project also generates relatively strong cash flows during commodity price declines. The break-even point is a bit higher than the Eagle Ford, so the company often stops development during recessions. But oil production continues to produce cash flow. Like Eagle Ford, the cash flow contribution is important due to higher prices for light oil products.
Heavy oil legacy projects are likely to be close to maintenance levels because the clear water area has a large cost advantage. Legacy projects currently produce quite a bit of cash flow. But Clearwater will quickly outstrip the cash flow from these projects. Because technology continues to advance, most companies keep a legacy surface like this because a technological advance may make a different surface more profitable in the future. But for now, Clearwater development will be a relatively high priority over legacy heavy-oil acreage.
The budget has been slightly modified over time to account for some strong operating results.
The company has improved production from maintenance levels to some growth. Commodity prices have been so strong that management made unexpected progress in lowering debt levels. That has allowed some budget flexibility and production growth to seep into the budget. Earnings growth was already there by the time Clearwater became viable because Clearwater improves production profitability as it gains on the production mix.
Projected Viking light oil is generally managed for cash flow. Growing that production is usually not a high priority. Eagle Ford’s production development is at the mercy of the operator. The Pembina Duvernay play is a light oil discovery that management is working to optimize prior to development. The development of the Pembina Duvernay is probably at least a few years away.
That leaves heavy oil. Heavy oil is the most profitable now. But earnings are also the most volatile. The growth of the Clearwater work will be the priority. But the work is relatively new. So it’s called orderly development (since management basically started from scratch). The remaining heavy oil money goes to legacy operations as they are profitable right now with generally quick recoveries.
Baytex has a new CEO who must assure the market that continuity will be a priority. In fact, he has some big shoes to fill because this company is in much better shape now than when his predecessor took over. Not many CEOs can pull that off.
On the other hand, the Clearwater game offers an opportunity for significant earnings improvements at various price levels along with heavy oil cash flow during commodity price declines. Therefore, it will be interesting to see what kind of balance of production management chooses.
The company has issued guidance to pay off debt at very low levels. Probably very cautious given the presence of a lot of heavy oil production. But for the first time in a long time, growth (profits and production) is in the future of the company. That’s good news for stock prices going forward.