Surge Energy Inc. (SGY) Earnings Call Transcript & Summary

Good morning. My name is Joel, and I will be the conference operator today. At this time, I would like to welcome everyone to Surge Energy Phase 2 Return of Capital conference call. [Operator Instructions] Mr. Paul Colborne, President and CEO, you may begin your conference.

Thanks very much. Thanks very much for your time today. My name is Paul Colborne, I'm President and CEO. I've got Jared Ducs with me, who's our CFO. And we've put out an exciting press release last night, and I just wanted to give a quick summary, background of information regarding the press release. Bottom line for us is our goal at Surge is to be the best-positioned crude oil [ DIVCO ] in Canada. [ To our goal ], there's really good companies out there like Headwater, like Tamarack, like Cardinal. So it's a fun battle. We're very competitive. We're very intense at Surge. We want to be at the top. So in 2022, we were the top performer with the TSR of 112%, Oil went to $94 with huge torque to oil prices on wedgethe Russian invasion. In 2023, we had a solid year. Oil average, though USD 77 per barrel during the year. We weren't the top performer, but we just kept grinding out our plan. And furthering our plan is also a key. You're not always going to be the top performer. Q1 this year, 2024, we had a great quarter, solid, hit every number of every of all of our 12 analysts that cover us, paid our dividend, paid debt down, like a very solid, good quarter. But again, crude averaged $77 in the quarter, and so it was good. What's exciting for us is now yesterday, we sold 2 noncore assets for $37 million. We met our next debt target. We have $52 million of additional free cash flow to allocate over and above our current dividend, which is $48 million. We're starting our share buyback program. We bumped the base dividend 8%, and we announced a large new Sparky discovery at Hope Valley with significant running room, all on -- all in one press release. So you can tell we're quite excited at Surge. Now dealing -- Jared and I'll just go through a couple of the points on the press release, dealing with the noncore sale, point number one in the press release that went out last night. Basically, we sold 1,000, 1,100 barrels a day for $37 million, about 3.5x cash flow, which is really good in this current market for noncore assets, applied it to our debt. And the exciting thing on that is it's very accretive to our bank line and our debt position. So we've already hit our next debt target, which Jared will walk you through. The key for us is why is Surge able to do this? And why do we continue to always be amongst the top firms for oil in our [ DIVCO ] space in Canada. It's all about asset quality. Myself or Jared can talk about how great we are and wave our arms and say how great we are, but there's one company I'm aware of in Canada that has 2 of the top 4 plays in North America as independently ranked this year by Peters, last year by Raymond James, a year before by National Bank in that search. So after this noncore sale, Surge has 85% of our production, 24,000 barrels a day, is in 2 of the top 4 plays in all of North America in terms of well payouts. And that's something we point to and attribute our success. Jared?

Thanks, Paul. I'll speak to a couple of points here. The first being point 2 in the release, which is the achievement of that Phase 2 net debt target and our return of capital framework. Management is very pleased to -- following these noncore asset sales to have reached our net debt target of $250 million and be below that, which in turn puts us into that Phase 2 return of capital framework. Paul discussed the $52 million that we have in excess free cash flow. And to be clear, that means additional free cash above and beyond the existing $48 million dividend to allocate to our shareholders at just USD 75 WTI oil pricing in terms of budget. In terms of the plan to allocate that $52 million of excess free cash flow, the management team is forecasting putting only $4 million of that into the base dividend. That will represent an increase of $0.04 per share from $0.48 annually currently to an anticipated $0.52 per share annually, that 8% increase. We expect that to be effective for the July 15 announcement, payable on August 15, subject to our Board's approval. I think it's crucial to note the basic payout ratio on that. Following the noncore asset sales, we anticipate 2024 cash flows from operations at $290 million, and the newly increased dividend represents only $52 million of that or 17.9% basic payout ratio. So a very sustainable base dividend. The great majority of that $52 million of excess free cash flow is expected to be directed back to our shareholders as well through 2 predominant forms in Phase 2, one being share buybacks and the other being net debt reduction and the implicit net asset value per share accretion that comes with that reduction. Inside of Phase 2, that $48 million is anticipated to be allocated on effectively a 50-50 basis, meaning up to 50% of the $48 million going towards share buybacks, the other 50% going towards further debt reduction. In terms of the buybacks, as per point 3, we intend to file shortly with the TSX a request to get approval to institute a normal-course issuer bid, or NCIB, looking to acquire up to 10% of the company's issued and outstanding common shares in our public float. In terms of the buybacks, when we look at our net asset value, our [ P, +P ] or 2P net asset value following the noncore asset dispositions is approximately $16.50 a share. So when we have Surge stock trading at the levels it's at today, we think it represents a compelling value and is why we're looking to buy back our shares at these levels. So anticipate further releases from us as we receive the expected approval from the TSX on the buybacks. Last point I'd make before turning it over to Paul is the achievement and adjustment of our new Phase 3 debt target. So we have adjusted that down slightly with the noncore asset dispositions from $175 million to $170 million. We really think of this as our terminal or final debt target. As we get towards that $170 million terminal debt target, look for Surge to allocate substantially all of our free cash flow and excess free cash flow towards shareholders through the newly increased base dividend, through the share buybacks that we'll be initiating. As well, management will be looking -- as we get towards Phase 3, looking to add a growth wedge to the company in the order of 3% to 5% of production per share in terms of allocating additional value back to our shareholders. That's really what you can expect from Surge here as we work through Phase 2 and achieve our terminal debt target of $170 million. So with that, I'll turn it back to Paul to give some more color on our exciting new Sparky oil discovery at Hope Valley. Paul?

Yes. So one little point on the last slide. So we're not pushing out a little free cash flow yield or shareholder returns to shareholders. Surge has been written up by 2 firms, Peters & Co and Ninepoint Partners as having one of the best free cash flow yields of any oil company in Canada, 16%, 17% free cash flow yield. We're just continuing now to push it out to shareholders in a staged manner as we hit these debt targets, and it's really exciting. So we're not pushing out just any old free cash flow yield, we're pushing out one of the top free cash flow yields in all of Canada of any oil company. And again, I attribute that back to the asset base. So to tie into the asset base, and I segue here, this has taken -- imagine how you -- anyone would feel on this call or otherwise taking 4, 4.5 years of gestation to have a baby. So in this case, our geologists found this 7 meters of [ pay ] at Hope Valley, vertical well. 7 year -- or 4.5 years later, we've drilled a big discovery well. We drilled 2 other wells that are good, but not great. Then we came up structure, shot a big 3D. And over the last 4.5 years, we've now assembled a 32 section position on this play. And the wells off confidentiality. You can see it, the market's been seeing it for the last 2 months. It hit over 300 barrels a day, and the average over the first 60 days was over 250 barrels a day. We see upwards of 100 drilling locations on this and over 175 million barrels of original oil in place. So it's very exciting. We've been chasing it for 4.5 years. And to come out with that announcement, it gives real scalability to the company in its Sparky core area. And we use the newer technology, it's slightly heavier. It's about 19 API. We use that technology of the multi-lots 12 legs, and it worked like a dream. We used a new Mud System, and that worked well. So we're thrilled about the well. It's still over 200 barrels a day in the third month out. So it's probably exceeding our type curve by a good 25%, 30%, 35%. Quite excited about that one. It's -- very little is booked in Surge's engineering, net asset value that Jared was referring to, and you'll start to see those bookings as we drill it up over the next few years.

Thanks, Paul. Just a few other notes here before we turn it over to the Q&A. We are continuing to follow our strategic hedging program and mandate, locking in both WTI pricing and differentials, notably the Western Canadian Select, or WCS, differential at better than our budgeted pricing. For example, we have put on swaps in excess of USD 80 WTI, well ahead of that $75 WTI budget level I referenced earlier on the call. With the TMX pipeline coming online that has helped really tighten up WCS differentials, and we have been taking advantage of those hedging out well into next year to protect these free cash flow levels that we've been discussing at better-than-budget price levels. We'll continue to systematically use these structures here to ensure the sustainability of the dividend and our capital program here at Surge. Last point for me on #7, update to the guidance, very minor effects here from the noncore dispositions. For the balance of the year, we only see approximately $5 million of impact to our cash flow from operating activities and free cash flow, yet we have substantially reduced the net debt draw on the company. We do see reductions in our op costs as well from selling those noncore assets. You'll see that all in the table presented in point 7 in the press release.

I guess the last point we'll leave you with is disciplined -- capital allocation discipline at Surge. We've came out with a strategy post-COVID when the whole world unraveled for oil. And basically, have stuck with that strategy, and the strategy is winning out amazingly well. And really, you see this latest press release here. So -- we -- our current dividend was -- we had a 6.8% yield. Our current dividend was $48 million. Because we hit the next step target, we have $52 million more free cash flow. We could have doubled the dividend. Well, that would be, we think, very risky and very -- not very disciplined. So of the $52 million, as Jared said, $48 million of that is going to go into debt -- further debt reduction and share buybacks, and just $4 million of that is going into the dividend. Now it's a nice 8% bump to the dividend, but it's "don't put your hand in the cookie jar too far". We don't believe that -- we want to show the market the discipline to keep marching along and systematically hitting these numbers, and the value proposition is huge. So consider us as having a balanced approach to capital allocation, where we're paying debt down, shareholders get the increase in net asset value. We're doing share buybacks now, meaningful big share buybacks. Shareholders get the benefit of -- there's less shares out. They own more of the company, and we don't have to pay the dividend on the shares that we buy back, bumps to the base dividend, a nice 8% bump to the base dividend. Last year, we bumped the base dividend 14% on the Enerplus acquisition. And then the last point would be as we hit the terminal debt target, it looks like around midyear next year, of $170 million, that's where we'd look to put in a 3% to 5% production per share growth wedge, so add a little bit of production per share growth into the mix. So that's our story. Very excited about the press release. The response has been amazing. Surge is one of the top performers on the energy index in a fairly weakish day today. So we're thrilled about that. Just thrilled for shareholders of Surge in our company that they have stuck with this and are seeing the plan actually outperform a lot of our peers. So that's our story. We'll flip it over now to the Q&A and open it up if there's any questions.

[Operator Instructions] Your first question comes from Amir Arif with ATB Capital.

Paul, just a couple of quick questions for you on that Hope Valley. You said it was outperforming type curves. Can you just tell us what is the cost of that 12-lateral? And what is your EURs [ set ] on your type curve?

Yes. So great question. So our original cost was about $2.6 million. It came in a couple of hundred grand above that, so right around $2.8 million. We think we can grind it down right post this breakup, which were coming out. We plan to drill 4 or 5 wells there right around the discovery well and establish production of battery and then branch out further like 15 miles away to the Northwest on the Enerplus lands. We see the same 7 meters of pay up there. So our ultimate initial well would be -- 125,000 barrels is what we book on our Sparky well. Now that's a multi -- or that's a multi-frac well.

Yes. So with the 12 legs, we anticipate an uptick in the EUR. On type curve, we anticipate about 175,000 barrels as the EUR on those 12-leg wells.

And we expect the payout would be in about 10 months at 75 oil and second payout in less than 2 years, right around 2 years.

Thanks...

And we see upwards of 100 locations, yes.

Yes. And I was just going to follow up on that. And the -- so the second-half drilling, it sounds like quite a few wells around the existing well. And then did you say 15 miles step-out? And is that -- do you feel that it's all connected up to that 15...

That's a very good question. So we see the discovery well. And then to the Northwest, way up on the Enerplus lines, we see a 7-meter Sparky well, [ sub-meter ] pay vertical Sparky well that's done 80,000 barrels, and it was a little bit commingled with the [ Lloyd ], but we think the rock up there is in the [ Bee Sand ] and even better than the rock we just drilled. So we're thrilled about that one, and we expect to drill that in the next 4, 5 months.

And then, Jared, just a question for you on the -- on that growth wedge budget. I'm not sure if I heard you right. Is that growth wedge coming now that you're at $250 million? Or is it coming when you get to the $170 million?

As we approach the $170 million. So as we have visibility towards Phase 3, that is when the growth wedge will kick in, sorry.

Your next question comes from Garett Ursu with Cormark.

A couple of questions for me just as a follow-up to Amir. With Q1 results, you mentioned you had 8 multi-leg lots planned for the second half. Now you're saying 6 will be at Hope Valley. Was that always in the plan? Or have you just recently reallocated some capital to Hope Valley for those 6 wells from somewhere else?

Great question, Garett. Yes, yes, with the success of that well that we talked about in the press release at Hope Valley being above our expectations, we have shifted capital here to effectively put a rig out here at Hope Valley through the balance of the year drilling. So definitely a reallocation of some of the [ multi-lots ] out here. We will also be drilling some [ multi-lots ] in a few other areas such as Betty Lake, where you've had great success with our extended reach 2-mile [ multi-lot ] wells, but the 6 wells of the 8 will be here at Hope Valley thanks to that great result.

Okay. And then on the noncore stuff, can you -- if you have it on hand, maybe the last time you drilled the well there, if there were any plans to spend any money or drill any wells there in the next 2 to 3 years? And maybe how many locations would have been on the assets sold?

Yes. So good question again, Garett. We have not drilled on Shaunavon or [ West Rose ] in the last 6 years. On Shaunavon and -- have never drilled a well at West rose. So there are locations on the books. I think Jared might even have the exact number, but they're truly noncore solid, low-decline properties, higher OpEx, and they creep up over time. And they've been solid cash flows that we take the cash and put it into the 2 core plays. But I would say we probably lost upwards of 100 drilling locations, probably 80 to 100 [ logs ] on selling Shaunavon that is comprised of Upper Shaunavon, Lower Shaunavon. And then West Rose would have had a good 6 or 8 [ logs ] books. So I'd say right around 80 to 100 [ logs ], but there are [ logs ] that we aren't even drilling and haven't drilled for 6 years. And to take the cash and redeploy it in 2 of the top plays in North America is kind of our strategy.

Makes a ton of sense. Any idea or can you give us an idea of how much abandonment might have gone with the noncore as well?

Yes, for sure. So in terms of ARO, [ West Rose ] had $4 million or $5 million associated with it. And then Shaunavon, I can get back to you with the total number there. It was relatively clean, but there are still several million dollars of active and inactive ARO that went with Shaunavon.

Your next question comes from Mike Mueller with Canaccord.

Just curious on how many of the 100 multi-lats locations you've kind of -- Hope Valley, how many of those are being attributed to the newly acquired lands? And are these assuming 1-mile legs on these?

Yes. So the 7 sections we bought, 4 were juicy, and we had 3 in the Crown sale that were we call them smoke, and they're on the edge and not as juicy. So of the 4, we would put 5 per section. So there's probably a good 25 to 30 [ logs ] on the 4 section, while -- I guess it'd be right on 20 [ logs ]. And it doesn't mean we hate the other 3. It's just they're not as juicy, and we wouldn't put them in the count. So getting to 100 now, we were about 25 sections, now getting the 7 yesterday at the Crown sale puts us up to 32. So we're probably north of 100 locations on the total land package.

Yes. Yes, exactly. So as per the release there, the 100 locations at 5 wells a section would represent only 20 of the 32.5 net sections. We're going to continue to delineate and drill and hope to increase those numbers with success through the program. To answer your second part of the question, yes, those are based on 12 laterals per well, a mile each or 1.6 kilometers.

[Operator Instructions ] Your next question comes from Michael Zuk with Athena.

I just wanted to know how you view the M&A landscape post these dispositions. Do you have more to come? And do you view yourself as buyers inside your core areas with more liquidity? Or do you have enough organic running room?

We definitely -- good question, Michael. We definitely have a lot of organic running room at Surge. So even with these sales, we probably have close to 1,000 drilling locations, just over just under. You never want to drill your bottom third, but probably a good 600, 650 juicy Tier 1, Tier 2 locations on 2 of the top plays in North America, low-cost play. So we drill at a pace of about 70 wells a year. So do the math on that, you're probably 8 years of juicy Tier 1, Tier 2 drilling. So we're not in a rush to buy other stuff. But when core area assets come up that makes sense for us, we don't hesitate to pounce like the Enerplus deal about 1.5 years ago. But we really haven't seen anything similar to that. There are a few little private [ cos ] in Southeast Saskatchewan that have come up for sale, a couple we've looked at. There's a couple of Sparky opportunities that are small in our core area, but nothing really big on the horizon, Michael, on an acquisition basis. And for shareholders, it -- trust me, if we had 3 years of juicy Tier 1, Tier 2 drilling, I would be happy. To have 7, 8 years of it is almost unheard of for a conventional oil producer. So we're really well positioned to keep this going organically.

And just quickly to follow up, Paul, I know your big fan of cash-in-your-jeans dividend. Can you kind of walk us through the decision to move to an NCIB versus just a higher dividend beyond the $4 million increase?

That's actually the best overall question. It really captures our strategy. We want to balance. So for an investor today in Surge, with the $52 million of incremental free cash over and above the dividend, our current dividend, coming into this meeting, was like 6.6% or 7%. And we could have doubled it. It's $48 million, and our new cash flow -- free cash flow to allocate is $52 million. But we want it to be sustainable. We've seen some of our peers overcook the goose, bump the base dividend too high and have to recount when the commodity price drops or something. So the $52 million of incremental free cash that we have to allocate, we're only putting $4 million to the base dividend. And $48 million goes to more debt reduction and meaningful share buybacks. So think of it as a balanced approach to capital allocation, base dividend, share buybacks, debt reduction. And as Jared said, when we hit the third debt target sometime next year, having already met the second one and hit the terminal one, we look for us at a 3% to 5% production per share growth wedge. And yes, it's a -- we call it a balanced approach. We don't want to put all the eggs in any one basket.

Your next question is from Amir Arif with ATB Capital.

Just one follow-up question just to the last question. On the $48 million that you can allocate to debt and buybacks, will it be fairly mechanical in terms of half going to debt reduction versus buybacks? Or is it a little bit more dependent in terms of where your stock price is relative to where you think the asset value of the company is?

I think the answer is a bit of both, Amir. So do expect us to be relatively consistent with a portion of that share buyback budget. So of the 50%, a component of that will be relatively mechanistic. But we do also want to be in the market supporting the stock at the right times when we feel that the equity value doesn't reflect the underlying net asset value of the company. So I want to be able to maintain some of that budget for opportunistic buybacks and a component of it for more mechanistic buybacks.

There are no further questions at this time. I will now turn the call to Paul for closing remarks.

I'll just sum up by -- as I mentioned to people, it's one of the most exciting times in Surge's history. Our strategy is working. And our strategy is a low-risk strategy that is based on high-quality assets. And what I mean by that is low risk, low cost, large oil-in-place conventional reservoirs, the waterflood while they outperform over time, deep expense of tight rock. So not only do we have the best free cash flow yield in Canada or one of them, as independently reported by Ninepoint Partners, Peters and others; we also have one of the lowest risk strategies. So in our model, the 20-mile [ march ], we love the -- doing what we're doing. We bumped the dividend 14% last year, another 8% this year. We've kept a super low payout ratio. We have over $100 million of free cash flow, and it's quite excited to get our share buyback program going, but we did want to show people the discipline to hit the second debt target, which we did yesterday before we started it. So now to have $52 million more capital to allocate -- free cash flow to allocate and put $48 million into the share buyback and more debt reduction and $4 million into the dividend, it feels like just a super healthy, sustainable model that we have. But I'll just point out and leave you with this, we're really intense. We want to be the top performer and a top-position company, but it all comes down to asset quality, and Surge has that. And that's our kind of secret sauce, if you will, for the company. The Sparky in Southeast Saskatchewan truly rank as 2 of the top 4 plays in all of North America. So that's our story, and thank you so much for your time today to patch in. It was fun and great questions. 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.