A weak q1 for surge energy, but the situation is much better now – surge energy, inc. (otcmkts zptaf) seeking alpha gas near me

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Just a few weeks ago, I launched the idea to replace Spartan Energy ( OTCPK:PTORF) with Surge Energy ( OTCPK:ZPTAF) as the former is in the process of being acquired by Vermilion Energy ( VET). I was charmed by the company’s excellent capital efficiency, acceptable decline rates and strong cash flows, allowing it to pay a dividend in the process. Surge has now published an update on its first quarter of 2018, and this seems to confirm my expectations.

I obviously still recommend to trade in the shares of Surge Energy through the facilities of the Toronto Stock Exchange, where Surge is trading with SGY as its ticker symbol. The average daily volume has increased to in excess of 800,000 shares. Surge Energy reports its financial results in Canadian Dollars, and I will use the CAD as base currency in this article. The Q1 results are a positive surprise

Surge Energy produced an average of 16,027 barrels of oil-equivalent per day in the first quarter of this year, which resulted in a total revenue of C$68.3M (which is an increase of almost 30% compared to the first quarter of 2017). The net revenue decreased to C$55M, but this was caused by a total loss of C$5.3M on hedging contracts compared to a (non-recurring) benefit of C$9M in Q1 last year. If you’d compare apples with apples and exclude the impact from the hedge portfolio, Surge’s revenue would have increased from C$47.8M to C$60.2M, which is a 26% increase.

Due to the higher finance and depletion expenses, Surge Energy reported a net loss of C$1.1M, or approximately 1 cent per share. That’s a bummer, but let’s keep in mind the income statement of an oil and gas company isn’t very important at all. What really matters are the cash flows.

Surge Energy reported an operating cash flow of C$24.2M which is a bit on the light side. One of the main culprits was –once again- the higher interest expenses (C$1.5M) and the higher decommission expenditures (C$2.2M). Considering Surge also spent almost C$35M on drilling new wells in the first quarter, Surge Energy was free cash flow negative, despite selling C$6.7M worth of assets.

Bad news? Not really. As a reminder: Surge Energy plans to spend C$99M on capital expenditures in 2018, which means the first quarter was particularly capex-heavy: it spent in excess of 1/3 of the total capex budget in just 1/4 of the year. That’s promising for the next few quarters, which should enable Surge Energy to generate more free cash flow. The Q1 capex was higher because Surge Energy accelerated the development of an additional well at the Valhalla light oil project.

And what’s also particularly pleasing, is Surge’s share repurchase program. Surge spent C$3.7M on buying back 1.863M shares. This indicates an average repurchase price of C$1.97 per share. The value is underpinned by the year-end reserves estimate

I consider the share buyback program to be a good idea considering Surge Energy is buying back its stock at a much lower price than the PV10 values seem to suggest Surge could be worth. Every year, Canadian oil companies have to report their oil reserves and the NPV10 values of those reserves. These reports have to be completed by independent consultants and provide some sort of guideline to check up on the value of the barrels of oil in the ground.

According to this objective report, the Surge-owned and operated oil fields contain 61.1 million barrels of oil-equivalent in the proved reserves category, and an additional 34.1 million barrels in the probable category bringing the total 2P reserves to 95.2 million barrels. As you can see on the next image, this also results in a PV10 based on the 2P reserves of C$1.55B.

Fine. But I like to be a bit more conservative. Whilst I’m fine with using a 10% discount rate for proved and producing reserves, I would like to use 15% for the non-producing reserves (this is 100% arbitrary. I just like to be a bit conservative). By doing so, the adjusted PV10 value comes in at C$1.32B.

After deducting the C$253M in net debt, the equity value could be guesstimated at C$1.07B, or C$4.60/share. Again, this isn’t ‘exact science’, but it does provide some sort of indication of the value of the oil reserves. And the banks appear to be convinced as well, as the credit line has been increased to C$350M. Investment thesis

Surge Energy is gearing up for a good 2018. The cash flows in Q1 were a bit disappointing as the price differentials with the WTI oil price doubled after one of the TransCanada pipelines ruptured. This made it more difficult for Canadian producers to sell their oil, and the price for Canadian oil dropped. I expect this situation to normalize in the next few weeks and quarters, and should increase the operating cash flow by 30-40%.