Yangarra Resource Stock: Still No Impairment Charges (OTCMKTS: YGRAF)

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Yangarra Resources (OTCPK:YGRAF) management had earlier announced that the reserves assumptions would change now that the company has enough history for the interval from which it produces oil and gas. The price is robust enough for the company to avoid an impairment charge. Most of the time, these types of adjustments affect later years much more than the initial production. That’s why management needed time to get the history.

The latter years often represent a much smaller share of the total reserves and they are produced at a much lower production rate. When all of this is properly discounted as a future value, the change is probably not as big as some would have thought.

Yet this company manages to evade the accusations of depreciation that seem to regularly plague its competitors. This is a possible sign (but not the only one) of low costs. Taking an impairment charge generally undermines a low cost argument by management. This company is able to make that low cost argument for a long time into the future.

(Canadian dollars unless otherwise specified)

Yangarra Resource Assessment and Debt Measures

Yangarra Resources Key Valuation and Debt Metrics Overview (Yangarra Resources March 2022, corporate presentation)

The beautiful thing low-cost production is the ability to increase both free cash flow and production. The result of this capacity is the significant increase in debt illustrated above combined with a rapid rate of growth. This company will have much higher production levels to provide greater cash flow during the next downturn in the industry.

The share price has changed considerably since the date indicated above. But the enterprise value is not as affected because the debt has probably gone down a bit. The company still has a decent value relative to cash flow.

One of the debt reduction goals is to maintain a debt-to-equity ratio below 2.0 during the next recession. There is a perception that the debt ratio was too high during the last recession in 2020 (although the severity of another recession is unlikely to match that of 2020). As a result, much of the industry is moving towards lower debt levels. This company included.

A company the size of this can easily hedge to protect the cash flow forecast shown above if management feels this step is necessary. Right now, exposure to current prices looks like quite an upside. It is therefore unlikely that management is currently hedging more than it needs to.

The other notable topic on the slide above has to be evaluation. Despite skyrocketing prices today, valuation is absolutely ridiculously cheap for a company that is increasing both production and cash flow. It will take a lot more runups to come close to a reasonable valuation. If it were a technology company, the stock price would likely be over $100 per share with the characteristics shown above.

(Canadian dollars unless otherwise specified)

Yangarra Resource Netback

Yangarra Resources Company netback calculation and comparison (Yangarra Resources, Fourth Quarter 2021, Earnings Press Release)

One thing I’ve said many times to many readers is that profitable businesses enjoy huge increases in profits when selling prices rise. This company illustrates this point very well. It was one of the very few companies to report a profit in any form in fiscal 2020. The company also reported enough cash flow from operating activities to verify that the profit was real (and not aggressive but allowed accounting).

Now that cash flow becomes a flood of cash. Interestingly, net net income in fiscal year 2021 is very high for the oil and gas industry. The average business in general brings in about 5% of sales as net income. This company is so above that. One could easily confuse this margin with a pharmaceutical company. Given that oil and gas prices have increased since the end of the year, this margin could increase further for the current fiscal year.

The key to profitability lies in production costs that would be typical of a producer of dry gas (or at least much less liquids). Management has found a very low cost interval that produces liquids to make an extremely profitable mix. Some would not consider this Tier 1 acreage due to the relatively high amount of natural gas production. Yet this acreage has been profitable at very low natural gas prices, as this liquid production is sufficient for decent profitability.

(Canadian dollars unless otherwise specified)

Yangarra Resources Well Operating and Profit Characteristics

Yangarra Resources Well Operating and Profit Characteristics (Yangarra Resources March 2022, corporate presentation)

Investors should keep in mind that the well cost shown above is in Canadian dollars. If that same well were priced in US dollars, it would be about 20% cheaper. This obviously makes a very cheap well given the production curve shown above. The rate of decline is very different from what the market is used to seeing with unconventional wells.

This means that the relatively high production lasts more than a year. This is much longer than many unconventional wells. More money up front through higher production increases the rate of return in good times and bad. Clearly, this direction has found an interval gem to produce from.

The best part is that the rate of return could withstand some unfavorable news when management finally had enough history to adjust the reserve ratio and probably a lot of other things to match the actual experience of the company. Today, with rising commodity prices, the performance of drilled wells is still fantastic. This rate of return always implies good performance during the inevitable cyclical downturns.

The future

This profitable business needed to finish reaching a sufficient amount of production to weather the downturns in decent shape. This will clearly be the case for the next recession. Many companies that started drilling after acquiring leases (and exploring leases) were taken earlier in the transition.

Fortunately, much of the industry learned from the experience of 2015, so the severe downturn in 2020 didn’t do as much damage as expected.

Now, surviving businesses like this can grow at an accelerated rate in the current environment while reducing debt balances. The market is still obsessed with debt ratios in 2020 when oil prices “bottomed out”. It is unlikely to happen again. Again, a little financial conservatism doesn’t hurt in this industry.

Management has plenty of Canadian acreage to drill for at least a decade to come. So far, the company has developed an interval. There is much more on the acreage to explore in the future. This business probably won’t need more square footage for decades.

As I’ve said in the past, this leadership has built and sold businesses before. The level of management experience is therefore exceptional for a company of this size. Combined with low debt and highly profitable wells, the investment risk is much lower than it would be for a typical junior oil and gas company. The stock is extremely undervalued as shown by the relatively high cash flow to company value.

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