Astra Oil Corp. (SGY) Earnings Call Transcript & Summary

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Surge Energy Strategic Acquisition Conference Call. [Operator Instructions] Thank you. Paul Colborne, you may begin your conference.

Thanks very much. I appreciate your time this morning. Surge Energy on the line, Paul Colborne, CEO; and Jared Ducs, the CFO of the company. Very excited about the meeting today, and thank you for your time. Just announced $160 million very exciting light oil acquisition in Southeast Saskatchewan, really, really nice company called Astra, private co, and quite excited about the deal. Really good people. Andy Greenslade, the President, I know very well, has built a really good company there, focused, operated high working interest, high netback light oil in Saskatchewan. Herb Pinder, the Chairman is a great friend and a long-time private equity guy in -- based at the Saskatoon, knows the Canadian oil patch well. Annapolis Capital, a great big shareholder and great shareholder in Astra. Camcor Capital, Lex Capital. So some really good backers there. What I'm most thrilled about is, they chose Surge Energy as their view of the top pick in Canada to roll their company into. Andy and I had a great initial chat, but we screen out very well as one of the top companies in Canada for positive financial leverage to oil prices. After 2 months of intense due diligence I'm thrilled they picked us to roll into. Can go the other way, but I'll turn it around and say we're very thrilled about acquiring Astra and rolling them into Surge. We're about 16,000 barrel a day company, they're 4,000 just over. So it's a really nice fit for us and a great base to get back into Southeast Saskatchewan, where I have been my whole career with Startech, Crescent Point, StarPoint Energy Trust and now Surge. I'm going to give you the big 4, I will say, on the call like this: reserves, production, cash flow and upside drilling locations. So reserves -- almost 16 million barrels of reserves, the recycle ratio, a good recycle ratio is, I paid a $1 and I'm going to get $2 back. This is $4. The recycle in this is over $4. So we paid $1, and we're going to get $4 back on the recycle ratio. It's off the charts good. Production is running for Astra about 15% higher than we have built in our budget. We're using 3,800 barrels for Astra next year as we kind of get it into our sustainable model. They're running over 4,300 barrels of production right now, with a couple of wells to still bring on. So they're running way ahead of our estimates. Cash flow when we first started talking to them was around $50 million to $55 million. Crude was $60, $59, $61, $62 range, rate in that range. Well, it's $74 million today -- or $74 WTI, sorry. So cash flow today is over $70 million, not $50 million to $55 million. So it's wildly accretive to our cash flow per share debt-adjusted. Jared is going to speak to that in a minute. So thrilled about that, obviously. Now inventory after 2 months, we thought, maybe there's 60 to 70 locations we like. After 2 months and even in the last 3 weeks, we're now up to 135 locations that Astra has that meet Surge's type curve. Now Surge, we focus on elite quality assets, and our Sparky play is one of the top in the country. But so is Astra's. Give credit to Astra. They built a beast down in Southeast Saskatchewan. Their wells payout in less than 6 months at today's oil price. So we don't see 70 locations. We see 135 locations, which is wildly higher than we anticipated. So we're very thrilled about that. It fits in really nice with Surge. In my whole career, I have had 4 different companies very successful that were in Southeast Sask. So we're thrilled about getting the base of 4,000 barrels and growing off that. Jared?

Thanks, Paul. I think I'll touch first on the ARO and environmental side of the acquisition. The Astra assets have a very attractive corporate liability management rating or an LMR of 5.5x, and a really low undiscounted decommissioning liability of only $12.9 million. Arguably, more importantly, they have next to no inactive wells, so very little inactive well liability. So a very clean asset base, which fits well with Surge's commitment to reducing the impact of our operations on the environment. On that front, from an ESG perspective, the Astra assets will also contribute significantly to our ongoing ESG initiatives where we focus on that reduction of impact. These assets, the Astra team are in the process of constructing a 45-kilometer gas gathering infrastructure system to conserve gas at critical facilities across their operating fields in Southeast Saskatchewan. This will significantly reduce the emissions from those fields. As Paul touched on, from a financial perspective, this deal is highly accretive to Surge on a debt-adjusted basis, 20% accretive to our debt-adjusted cash flow per share. And equally important, 30% accretive to Surge's debt adjusted free cash flow per share. So very excited about those metrics and the free cash flow profile, specifically to the Astra assets bolt on to Surge. We upwardly revised our guidance on the back of the strategic acquisition. We now anticipate exiting the year at 20,200 barrels a day, and we'll maintain that production level next year with only $110 million of capital due to, as Paul noted, the top decile capital efficiencies brought by not only the Astra assets, but Surge's assets, in particular, our Sparky play. With a continued focus on adjusted funds flow, enhanced free cash flow and free cash flow per share growth, this efficient capital program is going to drive an estimated 2022 adjusted funds flow number of $235 million at just $70 WTI. That's going to generate over $110 million in free cash flow for Surge and the shareholders next year at only $70 WTI. This would drive an all-in payout ratio of only 49% and generate over $0.18 of free cash flow per share. The summation of that is Surge's exit 2022 debt to cash flow at $70 oil would be only 0.8x. Today, we had another massive draw in U.S. oil inventory falling on the back of several large draws here in the recent weeks. We've seen many firms now calling for up to $100 WTI oil. So we're very excited about the crude market here. When we look at today's oil price of nearly $75 WTI, we forecast that we would go up to about $140 million in free cash flow next year. $265 million in adjusted funds flow and drive a net debt to cash flow ratio of only 0.6x, putting Surge's balance sheet in the top quartile of our peer group. Additionally, with the deal, we announced a new fully conforming bank line at $215 million with an extension through to the end of next year. This drives significant liquidity for Surge with over $40 million of forecast liquidity at the end of this year and with that free cash flow profile, well over $120 million of free cash flow next year at $65 WTI -- or sorry, liquidity next year. With that, we're very excited about the transaction. I'll turn it back to Paul for some closing remarks, and then we'll look to open up the call for questions.

Thanks, Jared. So just to sum up then, this is an asset that was on our horizon, and I want to be clear, I sought Andy out. And Andy looked at us for the better part of 2 months as well and his team. We looked at them. Our due diligence just kept getting better and better, and that's a tribute to what Andy built and his team and the private equity backers that back him are great local Calgary oil people. So we're thrilled with the deal there. I guess I just want to leave you with the free cash flow that Jared said. I think what's happening is that free cash flow is becoming the new earnings. It's the actual output and not an accounting earnings number, which has always been hokey in our business for years. For decades, everyone questions our earnings. But free cash flow, you can't -- it doesn't lie. And so thrilled to have oil almost $75. And as Jared said, that's like $140 million of free cash flow to Surge. Well, the last time crude hit USD $75 a barrel, what was Surge's stock price. It was $2.73. We've just done a wildly accretive, very exciting light oil acquisition, and we're setting new highs, but -- and I'm thrilled with that because people that buy our stock, we're not going to let people down on this call, because they backed us through the worst downturn anybody can imagine. You look at the steps we took through it, and now we're starting to be just slowly come out of the depths of the 2020 COVID crisis. It's thrilling for us to be able to show you the numbers and the numbers don't lie here. So we're excited about the deal. We will turn it over to people if they have any questions at this time.

[Operator Instructions] Your first question comes from Ray Kwan, BMO.

Paul, Jared, I just have a question on -- in regards to the Astra assets, more importantly, around the well inventory. You mentioned it was like 130 locations there. But can you describe kind of the typical IP rates, EURs and capital costs for kind of the inventory that you see there?

Yes, good question, Ray. It's turned out to be -- it's probably one of the top 5 plays Mississippi and light oil in Southeast Saskatchewan, one of the top 5 oil plays in all of Canada. And you're looking at well costs of about $850,000, no frac is needed. You're looking at Frobisher, Alida, Kisbey in -- the members in the Mississippian, [ some ideal. ] And the wells cost $850,000 payout in less than 6 months at today's prices. They've had some wells come on at over 300 barrels a day, but a typical well would come on at 125 to 175 barrels, let's call it 150 for $800,000. They have a steeper decline in the first year, and then they level out with a natural aquifer water drive, and they pay out like twice in 8 plus -- in 18 months. And that's actually better than our Sparky. And it's such a nice trade-off to our Sparky because our Sparky wells come on payout in probably 8 or 9 months right now. And then they flatten out and you waterflood them and they go on for 30 years and you get the better profit to investment ratios. But these wells in Saskatchewan will pay out 3, 4, 5x. A Sparky well will pay out 7, 8, 9x under waterflood. So it's a nice balance for us.

Yes, it's a great balance between those. Great IRRs and quick payouts and the long-life PIRs that we have at Surge. So really like that portfolio approach. To the last part of your question, Ray, we see EURs in many of these wells in excess of 120,000 barrels.

And then just a follow-up, I guess, in terms of the maintenance capital required for these assets here. Can you comment on that? And then, I guess, I'll ask my second question on that one. It's just, obviously, you guys are going to be generating a ton of free cash flow and your leverage targets. It's -- hopefully can be less than 1x by the end of next year. Can you comment on what your thoughts are post reaching your debt targets in terms of how you think about capital allocation, whether return of capital, dividends and so forth?

Great. Another great question. It's nice to be talking about those issues rather than survival and whatever was 2020 crisis mentality. So it's kind of thrilling about that. But one thing we are doing is, we've decided to run leaner because of the changes to the Canadian chartered banks of which, Ray, year 1, they have seemed to be more choosy about what companies do they want to be in the business and they're picking their winners. We're thrilled to say BMO is backing Surge. So we have a great 10 bank syndicate that has given us a completely new bank line, redone. Jared's done a great job with them. So yes, we're -- our debt targets, we're sitting there saying, let's pay our debt way down and be in complete control of all those capital allocation levers. So Believe me, I own 12 million shares. I want to get back to the dividend. But I think priority wise, our goal is pay down first lien debt is #1. So probably go 6 months to 1 year before we start to think about putting the dividend back in, get into that crazy free cash flow state next year, then we'll start looking at what we had before was a 5% growth wedge, a nice dividend, about a 5% to 7% yield, call it, 6%, and then a free cash flow yield in this case, which should be more like 8%, 10%, 20% is what we have now. When you add those other things in, it would be 7%, 8%, 9%. So you're in that mid- to high teens annual rate of return as a company.

Good points. And to kind of answer your initial question, Ray. That's, again, one of the things that attracted us to this asset was the asset quality and what it generates financially. To maintain the production levels embedded in here around that 3,800 to 4,000 barrel a day range next year on these assets, only takes about $18 million to $20 million in capital. And as Paul mentioned, at today's prices, these assets are generating the better part of $70 million in corporate cash flow. So you've got an incredible wedge of free cash flow that these assets provide, which we've embedded in the guidance numbers, but that's one of the attractions to this asset in this area in general.

Your next question comes from Michael Zuk, Athena Capital.

Congrats on the deal. Good response from the market. Just 2 very quick questions. I think Ray partially asked my first one. But how do you look at the division of capital, the $110 million in capital, devoted between the Sparky and Southeast Saskatchewan next year notionally on a percentage basis?

Good for you. Because a lot of people forget, including I think this will be a little bit of a surprise even to the Astra shareholders, but our other assets are phenomenal. If you take the National Bank book that they put out a couple of years ago of the top plays in all of Western Canada, our Slave Point, it's an amazing asset, but it's a little bit higher oil price assets. So you want to be $65 WTI or higher. Well, crudes tickling $75. That's a 600 million-barrel pool we have up at Greater San. The oil cut is 55%. The decline is extremely flat. The waterflood is working. We have upwards of 100 locations there. Our Shaunavon is in the top. I think it's 8 plays in all of Western Canada. And our Valhalla play, the Doig and the Montney, those locations and those reservoirs. The Doig is some of the best wells in Canada when we drill a Doig well. And our Montney has turned out to be phenomenal. So all 5 of our plays, now 4 we had before and then bolt-on Southeast Sask are in the top place. So we'll be looking at Sparky, Southeast Sask. We're going to now start to spice the location inventory here, the drill wells with some Sawn looks and some Valhalla looks and some Shauneman. So it will kind of go in that priority. It'll be Sparky, Southeast Sask, but now start to put -- drill 2 to 4 wells a year at Sawn, drill 4 to 6 wells a year at Shauneman, drill a couple of goods -- Valhalla wells a year. And then the dominant plays will be the Sparky and Southeast Sask. But great question. And I'm thrilled to say our other assets are good. They're just not as growthy as the Sparky and Southeast Sask.

Great. That's helpful. And secondly and finally, just to give some existing shareholders a little bit of sauce, is there a lockup on the new shares for this deal?

Correct. Yes. So as we had announced in the press release, there is a lockup. We've got up to 9 months locked up on 68% of the shareholders, the 2 large shareholders as well as with the directors and officers of the company. So they're in supporting the stock and very excited to be part of the story.

Your next question comes from Jeremy McCrea, Raymond James.

Mike had some good questions there. So just maybe a bit more of a follow-up there. If you have such good well results, I know there's a lot of free cash flow, but why not I guess, make hay while the sun shining here in terms of drilling more of these wells. If you get that quick of a payout, why -- what's holding you from accelerating some of that spending here just to pay down and just create more value creation, I guess, in a given year here?

That's actually a really, really good question. We might have to invite into our weekly management meeting. Because you would be right if we weren't so, call it, undervalued or cheap or whatever you want to call it. So we'll probably look to do that when our stocks back to $273 or $2 or $1.75. But when you're trading at -- even today, we're trading at less than 2x cash flow, probably 2x cash flow per share. While traditional multiples are 4 to 8. I think Headwater at 8x next year's cash flow per share, a brilliant growth company. I like them a lot. Great. Great story. We're barely 2x cash flow per share, and I think that's at $65 oil. So we're probably less -- we're probably 1.5x if you took current oil price. And the other thing we want to do is, we're really a sustainable company. So you look at us and Surge had one of the lowest declines at 21%. These guys were a growth company with a higher decline around 38%. You put the 2 together, we're at 25 -- we could easily go and spend some of that free cash flow, about $40 million and goose the production and cash flow per share and look good. But once you start taking your decline up to 27%, 28%, 29%, it becomes less sustainable. So in our case, our goal is to get back to our sustainable free cash flow dividend model. So the discipline, I'm really proud. I mean, we could easily even goose the exit-rate numbers with their production coming in largely 500, 600 barrels higher than we thought or have built into our numbers. We're going for the sustainable model, free cash flow model that leaves us all those great capital allocation levers that Ray touched on earlier available to us.

Yes. I think to your point, we're going to always be watching. We apply a portfolio approach to our assets. So to the extent these assets continue to outperform, you may see us moving that $110 million capital budget around between the assets. As Paul noted, we have a nice suite of different assets that provide different attributes to the company's growth profile. So you may very well see us allocate more of that $110 million to these assets. That will be something we continue to monitor and adjust going forward.

[Operator Instructions] Your next question comes from Josef Schachter, Schachter Energy.

Congratulations Paul and Jared on the acquisition. A question on the balance sheet. This transaction will close in Q3. So there will be -- what price is being used for the equity of the deal for the shares? And your share count was 379.2 million. Where is the share count at the close of this transaction?

So Josef, the exchange ratio was about 3.17. The VWAP used was $0.63. So we anticipate sitting around 608 million shares outstanding pro forma the deal that closes in early August. And I'm sorry, your first question with respect to the balance sheet was?

The equity component. Like you have negative equity at the end of Q1. Two parts there would be is: one, this transaction in Q3 would give you positive equity from the new share count, but also would there be a decision yet to reverse the impairment, the significant impairment of last year?

Good questions. Yes, I agree with that first comment. And yes, that's something us and all our peers are looking at with the continued strength and rapid rise in oil prices, it would not surprise me if many across the peer group would be reversing significant component of the impairment that was booked in the depths of the COVID crisis. And so Surge would definitely be looking at that as well as part of our Q2 normal course financial reporting obligations, for sure.

Congratulations.

Thank you.

Your next question comes from Trevor Reynolds, Acumen Capital.

Most of the questions I had have been asked. But just curious on the PDP value if you're able to provide that. And anything on the NPV-10 value as well.

Yes. We've just got a good run here. We chose not to do strip, which is $69. We did $65 flat pricing. I can get you that. I think PDP+P. I'll send you that run. I think we sent it to Jeremy. I can send it to any analyst that wants it, but it's pretty attractive. We'll show you that. I think we're around $120 million, but the production is outperforming the engineering report by about 20% in May. So we're paying just over PDP on a $65 flat price deck, and that's PDP+P.

Yes, they're outperforming even PDP+P by 11% here. And as Paul referenced, the PDP is being exceeded by about 22%, which is kind of baked into those outperformance on production -- current production rates.

Great.

I'll send you that run, Trevor, after the call.

Your next question comes from Baltej Sidhu, National Bank.

Sorry, I was just on -- I had my phone on mute there. Could you talk about the PI ratio versus the payout of the acquired assets versus the Sparky? And how do you plan to allocate the capital going forward?

Yes. So I think as we've referenced there, these wells have a little bit quicker payouts. They're sitting below 6 months on the acquired assets. The Sparky sitting nicely at that 7-, 8-month payout ratio. So -- as we noted, we're going to be balancing that right now, anticipating spending about $20 million next year, drilling somewhere around 15 wells on the acquired assets. And then that will be layered into the existing Surge drilling program on the assets, as Paul articulated earlier. And then we will continue to watch that as these wells outperform. Again, the nice thing about having the suite of assets we do is that we can allocate the capital between them and move the levers around to ensure we're optimizing PIRs as well as getting those nice quick payouts. It's a good blend.

Any other questions for Jared and myself?

There are no further questions at this time. Please proceed.

Okay. I will close up with one thing. I'm extremely competitive. And our goal is not to be running one of the better oil companies in Canada. We want to be the top performer in the country. And when you look at our assets, all 5 of our core areas rank in the top. I think it's 10 oil plays, 2 rank in the top 5 in all of Western Canada. Our balance sheet is now top quartile. It's better than any company I've ran. We've decided to run leaner. And part of this deal was, as Jared touched on, that it brought such immense free cash flow. Our goal is to be the top performer in the country, and it stems from top people, elite assets and we have those. And then you add the balance sheet in and the massive leverage to positive financial leverage, Surge has to crude oil prices running. We -- none of us were counting on crude being $74 this morning and a lot of top firms, I can't believe it, are calling for $80 to $100 oil this year or really soon. So we know that you guys are looking and one of the key things Astra pointed out to us, the Astra management and Board and shareholders. There's not many good companies left in Canada. There's Whitecap and Enerplus up at 100,000-plus flowing barrels a day. There's ourselves and Tamarack in the 20,000 to 40,000, there's not many companies. So you're going to be looking at who are the top companies, proven management, elite assets, awesome balance sheet. We're kind of thrilled about it, and we really appreciate your time today, but our goal is to be the top performer. We know we have to go and earn that and go put out great quarters. We are a 2022 story, and we think the market is smart, and we're starting to see some of the analysts on this call go this company is set to roll in 2022. So thanks for your time today, and I really appreciate the very good questions. So we will sign off. Thank you.

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.