By Steven Ralston, CFA
OTC:ALVOF | TSX:ALV.V
READ THE FULL ALVOF RESEARCH REPORT
Alvopetro Energy Ltd (OTC:ALVOF) (TSX:ALV.V) is an upstream natural gas producer and midstream operator (pipeline and gas processing facility) with operations that serve the industrial area of Camaçari, which is just north of Salvador, Brazil’s fourth largest city. Impressively, the company has developed Caburé natural gas field and has achieved five consecutive quarters of increasing levels of gas and condensate production, bolstered by rising pricing under an attractive long-term gas sales agreement.
Management is now embarked on a plan to open the Gomo Field to the north by drilling two exploration wells, the first of which (182-C1) is slated to be drilled in December following the completion of rig maintenance. Construction on a 9-kilometer tie-in pipeline commenced in July 2021 and is expected to be completed by early 2022. In addition, Enerflex has been notified to increase the gas processing facility’s operational production capacity to 500,000 m3/d. Management expects that the additional 25% increase in capacity will be available by June 1, 2022.
Management’s robust growth plan is being funded organically by the company’s improving operational performance, which is being bolstered by a strong pricing outlook.
RECENT & PROJECTED DEVELOPMENTS
Recent Monthly Production Announcement
On November 4, 2021, Alvopetro Energy announced sales volumes for October. Based on field estimates, total sales volumes averaged 2,382 boepd, a 6.1% decrease over September’s average sales volumes of 2,536 boepd. Natural gas sales averaged 13.7 MMCFPD (2,283 boepd) while condensate sales averaged 99 bopd.
Floor Price Increase
Under the long-term Gas Sales Agreement (GSA) with Bahiagás, the floor and ceiling prices for natural gas are re-set on a local currency basis as of February 1st and August 1st. On August 4th, Alvopetro Energy announced that effective August 1, 2021 the new contracted natural gas price floor is BRL1.31/m3, up 23.6% from the February 1, 2021 price floor of BRL1.06/m3 ($5.88/mcf). The floor price equates to BRL37.03/MMBtu or BRL36.13/mcf or $7.72/mcf. Based on commodity price forecasts and US CPI trends, management anticipates that the prices received will migrate within the contract bounds to the ceiling price to US$10.15/mcf beginning on February 1, 2022.
Management raised guidance for 2021 EBITDA for the second time. Due to the company’s improving operational performance, along with a strong pricing outlook, in November, management raised 2021 EBITDA guidance to over $23 million, which was up from June’s revised guidance of over $20 million. Initially, management’s guidance was $17 million. Sales volumes continue to rise sequentially almost every month, but also the increases in benchmark prices (which are driving higher realized prices through the semi-annual price redetermination process) have contributed to the improved guidance.
Working Capital at Record High
As of September 30, 2021, working capital was $6.84 million, a record high for the company.
Uses of Operational Cash Flows
Under management’s strategic plan, a portion of the positive cash flows from natural gas and condensate sales has been utilized to reduce the company’s debt by over 50%. About 50% of the current operating cash flow is being used to develop the Gomo Field in order to expand the company’s reserves. And part of the remainder is being utilized to fund shareholder dividends, which began September 2021.
Early Debt Repayment
Funded by the company’s successful ramp up of production, management was able to deliver on its debt reduction plan. Utilizing a portion of the positive cash flows from natural gas and condensate sales, Alvopetro has thus far repaid $9.0 million. As of September 2021, the outstanding balance of the credit facility has been reduced by 58% to approximately $6.5 million.
In 2019, Alvopetro entered into a Senior Secured Credit Facility with Cordiant Capital with a cash interest rate of 9.5% per annum and a 3% PIK interest rate. The facility had an original maturity of October 8, 2022. The outstanding balance had risen to $15.4 million by the end of 2020.
During the first quarter of 2021, Alvopetro repaid $2.5 million of the Credit Facility, which reduced the balance to $13.0 million as of March 31, 2021. Then, on May 3, 2021, Alvopetro Energy restructured this debt through an amendment that extended the maturity date by one year to October 8, 2023. In addition, the amendment eliminated the facility’s 3% PIK interest as of April 15, 2021. The 9.5% cash interest rate was not altered.
Subsequently, on June 4, 2021, an additional $3.5 million was repaid since the capital spending on drilling 182-C1 and 183-B1 has been deferred to later in 2021. At the end of June, an additional $2.0 million was repaid, and during the third quarter, another $1.0 million was repaid. The balance of Credit Facility is now approximately $6.5 million.
Board Declares First Dividend
On September 21, 2021 the Board of Directors declared the company’s first dividend of $0.06 per share. Shareholders of record on September 29, 2021 received the declared dividends on October 15, 2021. The company paid out approximately $2.0 million in dividends.
Upcoming Operational Plans
Operationally, management focused on producing natural gas and condensate from the Caburé natural gas field and advancing the company’s Gomo natural gas project to production.
Management plans to drill two natural gas exploration prospects: 182-C1 and 183-B1. Following a rig maintenance program, a contracted drilling rig is expected to commence drilling182-C1 in December 2021. The drilling costs for the each of two wells are estimated to be $3.3 million.
The 9-km tie-in line (dubbed the Gomo/Murucututu pipeline extension) will connect the 183-1 well to Alvopetro’s existing 11-km Caburé gas field transfer pipeline. In July 2021, field construction commenced, including the welding of pipe and the opening of ditches in preparation of installation. The estimated cost, including field production facilities, is $2.1 million. Management anticipates tie-in line will be completed and the 183-1 well tied-in during early 2022.
In the second half of 2022, after the increasing the gas processing facility’s operational production capacity, management plans to stimulate and tie-in of the 197-1 well and other follow-up development wells as part of an $8.8 million capex program.
Temporary Inefficient Market (September 8-9, 2021)
On September 7, 2021, Alvopetro Energy announced that the previous announced share consolidation and split have been completed. In order to reduce the costs associated with many shareholders holding small amounts of shares, the company effected a 2,100 to 1 share consolidation, which was followed immediately by a 1 to 700 share split. The net effect was a 1 for 3 reverse split while reducing number of shareholders by those who were holding small positions of less than 2,100 shares. The move will reduce the administrative costs associated with the expected declaration of a dividend. Those shareholders who held less than 2,100 common shares as of September 3, 2021 are able to receive a cash payment of CDN$1.12 per pre-consolidation/split common share held. Temporarily, for 30 days, the company’s ticker was ALVOD.
The share consolidation/split temporarily created an inefficient market with ALVOD trading between $8.00 and $1.36 in the two days after the consolidation.
THIRD QUARTER FINANCIAL RESULTS
On November 9, 2021, after the close, Alvopetro Energy reported results for the third quarter ending September 30, 2021. Natural gas and condensate sales were $9.96 million, another record for the company since initiating deliveries of high pressure sales volume through its controlled midstream infrastructure. Currently, sequential comparisons are more meaningful than year-over year (YOY) ones.
Sequentially, natural gas, oil and condensate sales increased 19.5% to $9.96 million compared to $7.57 million in the second quarter of 2021, driven by a sequential 4.0% increase of overall sales volumes to 2,459 boepd. Natural gas sales averaged 2,350 boepd (14.10 MMCFPD) while condensate sales averaged 107 bopd. Natural gas price realization was $7.07 per MCF, a 16.7% sequential increase from $6.06 per mcf in the second quarter. The realized condensate price was $79.36 per bbl.
Royalties and production taxes were 9.1% of natural gas and condensate sales. The Caburé natural gas field is subject to a 10% government royalty and a 1% landowner royalty while the Bom Lugar field is subject to a 5% government royalty and a 0.5% landowner royalty. The Mãe-da-lua field and Block 182 have an additional 2.5% gross-overriding royalty. However, royalties are determined at an inherent reference price attributable to production of raw natural gas produced , which is lower than the GSA contracted sales price, which results in a lower effective royalty rate. The reference price is also tied to current Henry Hub prices.
Sequentially, production expenses increased 4.2%, primarily due to higher fees associated with increased sales volumes. Most of Alvopetro’s production expenses are related to fees paid to Enerflex for the operation of the gas processing facility and transfer pipeline, along with unit operating costs on the Caburé upstream assets. Though varying slightly with volumes, since the initial two quarters of production (3Q & 4Q 2020), production costs have stabilized in the $3.60 to $3.70 per boe range.
G&A expenses increased 9.9% sequentially, mainly due to increased professional fees and higher personnel costs due to increased activity levels, along with general corporate costs.
Interest expense declined 17.6% sequentially to approximately $686,000, primarily due to the balance of the Credit Facility being reduced from $15.5 million to $6.545 million by the end of the third quarter. The other major component of interest expense is related to interest on the capital lease with Enerflex. The 3% interest-in-kind (PIK) on the Credit Facility was eliminated as of April 15, 2021.
The company’s tax expense of $1.37 million in the third quarter is an anomaly since it reflects both Brazil’s statutory corporate tax rate of 34% (15% corporate tax, 10% surtax and a 9% social contribution tax) and the deferred tax expense that relates to tax deductions recognized in 2021 in excess of accounting deductions. The SUDENE (SUperintendência do DEsenvolvimento do NordEste or Development Superintendency of the Northeast) tax incentive is lowering the company’s effective tax rate to 15.25% which is effective until December 31, 2030.
The reported quarterly profit was $1.490 million (or $0.0422 per diluted share) versus a loss of $6.483 million (or $0.1847 per diluted share) in the comparable quarter last year. Third quarter’s earnings were negatively impacted by an unrealized foreign exchange loss of $1.81 million. Without the recognition of the unrealized foreign exchange gain, earnings for the third quarter would have been $3.30 million (or $0.0935 per diluted share). As of September 30, 2021, working capital was $6.84 million, a record high for the company.
With the realized sales price at $44.04 per BOE, royalties at $4.02 per BOE and production expenses at $3.64 per BOE, the operating netback improved to $36.38 per BOE versus $31.58 in the prior quarter.
The current P/S valuation range for this group of comparable companies is between 2.56 and 6.80 times TTM revenues. Utilizing comparable analysis, the target price for Alvopetro Energy is $4.35 per share, which is based on an expected second quartile price-to-sales multiple.
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By Steven Ralston, CFA