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Alvopetro Energy Ltd ALVOF ALV is an upstream natural gas producer (natural gas production with P-2 reserves) 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. In addition to the company's conventional Caburé natural gas field, Alvopetro has tight gas exploration prospects in the Gomo Field.
Impressively, Alvopetro has developed Caburé natural gas field, including the construction of midstream assets, and achieved a one-year anniversary of production that includes increasing levels of quarterly gas & condensate production, along with a long-term Gas Sales Agreement with attractive floor and ceiling prices.
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 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. Part of the remainder is slated to fund a shareholder dividend, which is expected to be initiated in 2022.
Recent Monthly Production Announcement
On August 4, 2021, Alvopetro Energy announced sales volumes for July. Based on field estimates, total sales volumes averaged 2,412 boepd, sequentially flat over June's average sales volumes of 2,414 boepd. In addition, our se. natural gas sales averaged 2,309 boepd (13.39 MMCFPD) while condensate sales averaged 109 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. The floor price equates to BRL37.03/ MMBtu or BRL36.13 Mcf.
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 $8.0 million. As of August 2021, the outstanding balance of the credit facility has been reduced by over 50% to approximately $7.5 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. The balance of Credit Facility is now approximately $7.5 million.
Second Quarter Results
On August 12, 2021, Alvopetro Energy reported results for the second quarter ending June 30, 2021. Natural gas and condensate sales were $8.18 million, a record for the company since just initiated deliveries of high pressure sales volume through its controlled midstream infrastructure. Year-over year (YOY) comparisons are meaningless since prior sales volumes from the Mãe-da-lua field during the second quarter of 2020 were de minimis (averaging averaged 6 bopd).
Sequentially, natural gas, oil and condensate sales increased 17.9% to $8.18 million compared to $6.94 million in the first quarter of 2021, driven by a sequential 8.55% increase of overall sales volumes to 2,361 boepd. Natural gas sales averaged 2,252 boepd (13.06 MMCFPD) while condensate sales averaged 105 bopd. Natural gas price realization was $6.06 per MCF, a 6.7% sequential increase from $5.68 per MCF in the first quarter. The realized condensate price was $74.47 per bbl.
Royalties and production taxes were 7.4% 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 11.4%, 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 transfer pipeline and gas processing facility, along with unit operating costs on the Caburé upstream assets.
G&A expenses increased 21.7% sequentially, mainly due to increased professional fees and higher personnel costs.
Interest expense declined 16.2% sequentially to approximately $833,000, primarily due to the balance of the Credit Facility being reduced from $15.5 million to $7.545 million by the end of the second 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 $1.76 million in the second 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. In the future, a SUDENE (SUperintendência do DEsenvolvimento do NordEste or Development Superintendency of the Northeast) tax incentive is expected to lower the company's effective tax rate to 15.25% once the company has received formal approval for the regional incentive.
The reported quarterly profit was $3.637 million (or $0.0347 per diluted share) versus a loss of $1.168 million (or $0.0119 per diluted share) in the comparable quarter last year. The second quarter's earnings were positively impacted by an unrealized foreign exchange gain of $2.811 million. Without the recognition of the unrealized foreign exchange gain, earnings for the first quarter would have been $0.826 million (or $0.0079 per diluted share). As of June 30, 2021, working capital was $4.50 million.
With the realized sales price at $38.08 per BOE, royalties at $2.82 per BOE and production expenses at $3.68 per BOE, the operating netback improved to $31.58 per BOE versus $28.52 in the prior quarter.
Guidance
Management anticipates that production from the Caburé natural gas field will continue at rates between 10.6 and 13.8 MMCFPD. Overall sales volumes (natural gas and associated condensate sales) are expected to average between 1,850 and 2,400 boepd for the remainder of 2021.
Due to the company's improving operational performance, along with a strong pricing outlook, in early June, management raised 2021 EBITDA guidance to over $20 million, up from initial guidance of $17 million. Sales volumes continue to rise month by month, but also the benchmark prices have contributed to a higher semi-annual price redetermination.
Operational Update
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.
During the second half of 2021, management plans to drill two natural gas exploration prospects: 182-C1 and 183-B1. Following a maintenance program, the contracted drilling rig is expected to be accepted by the end of the third quarter. Total drilling costs are anticipated to total $6.8 million for the two wells.
The 9-km flow 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, field construction commenced. Welding of the pipe has begun and ditches are being opened in preparation of installation. Management anticipates flow line will be completed and the 183-1 well tied-in by the end of 2021.
During the first quarter of 2021, civil construction was completed at a cost of $0.3 million and long-lead items were purchased at a cost of $0.4 million. The pipe for construction of the pipeline was purchased at a cost of approximately $0.5 million and delivered in the field during the second quarter of 2021. The estimated cost, including field production facilities, is $2.1 million.
Dividend Policy
The Board of Directors formally adopted a dividend policy and strategy, which includes the expectation of initiating the payment of dividends (denominated in US$) as soon as the first quarter of 2022. The dividend will be determined after the 2021 exploration drilling campaign is completed and the 2022 capital budget is finalized.
To facilitate the payment of dividends, the company plans to conduct a one-time, small-lot common share repurchase program, which may be implemented through a buyback or by a share consolidation, which was approved by shareholders on August 12, 2021. The cost is expected to be less than $1.0 million.
Management's Strategy
Management's vision is to make Alvopetro Energy a leading independent upstream and midstream gas company in Brazil. Phase 1 consisted of becoming commercial producer of on-shore natural gas producer in the state of Bahia in Brazil, which was achieved in July 2020. The cash flow from the production is expected to help fund additional developmental initiatives and return a healthy dividend to shareholders.
Based on the development of the company's Caburé's P2 reserves, management has forecasted an EBITDA profile at the floor price in the sales agreement with Bahiagás (light green bars in the above chart). In 2020, the company generated EBITDA of US$6.22 million, most of which has been either utilized to reduced debt or added to working capital. For 2021, projected EBITDA is over US$20 million, including the impact of forecasted G&A expenses. In 2021, almost all of the projected EBITDA is anticipated to be consumed by capital expenditures (grey bar), debt principal repayment and interest costs on debt (blue bar), a UPGN fee to Enerflex for the gas facility (yellow bar) and taxes (red bar).
In mid-2021, the Disciplined Model above was amended to incorporate the recent increase in the price floor in the gas sales agreement. Over the 10-year planning period, now approximately US$111 million would be available for investment in upstream projects over and above the current plans for the Gomo Deep Basin Project. At the discretion of the Board, other uses of cash flow are the acquisition of some of the expected divestitures by Petrobras in the Recôncavo Basin, additional dividends to shareholders, share buybacks etc. Management renegotiated the company's existing credit facility (in order to lower interest costs) and extended the maturity of the company's debt, which permits more funds generated from operations to be allocated to acquisitions, exploration and dividends.
Management's medium-term objective (or Phase 2) is to maximize the capacity of both the transfer pipeline and gas treatment facility up to full capacity (500,000 m³ or 17.657 MMCF per day), which would increase the company's EBITDA to US$31 million.
Valuation
The current P/S valuation range for this group of comparable companies is between 2.65 and 6.36 times TTM revenues. Utilizing comparable analysis, the target price for Alvopetro Energy is $1.35 per share, which is based on an expected first quartile price-to-sales multiple.
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