Yangarra Resources Stock: Cheapest of the Cheapest (TSX:YGR:CA)

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(Note: This article originally appeared in the July 28, 2022 newsletter and has been updated as needed. This is a Canadian company and reports in Canadian dollars unless otherwise noted.)

Smaller companies like Yangarra Resources (OTCPK: YGRAF) suffer from less than optimal market exposure. There are many small businesses that receive little or no market attention except from small investors. For investors, the “name of the game” is to find one of those small companies that performs exceptionally well, then hang on until institutional attention pulls stock prices toward better valuation. .

Yangarra Resources was one of the few companies that declared a profit in fiscal year 2020. Anything close to a profit was an outstanding performance as many companies lost a lot of money in fiscal year 2020. It also meant that this company had no impairment charge, which was another achievement for the year.

Now that the preliminary indication of above-average profitability has been followed by industry-leading profits in a much friendlier industrial environment. Other indicators include the ability to repay debt as well as production growth. Shareholder returns are not yet a priority as growing at a size that appeals to institutional investors should be the first priority.

In the meantime, investors can invest in a company that sells for less than twice annualized earnings. This low multiple should provide some downside protection even if oil prices decline as the market fears. Growing production with a very low break-even point will provide additional protection against falling stock prices. The low breakeven price of wells means the company can increase production when many competitors can’t (while also generating decent cash flow).

Since the article was written, recession fears have increased significantly. But a company that can report a profit in a tough year like fiscal 2020 is likely to weather the current challenge. It’s about that rare business that can repay its debt to the satisfaction of the lender while increasing its production. This growth will also provide better downside protection.

(Canadian dollars unless otherwise specified)

Yangarra Resources Company Overview

Yangarra Resources Company Overview (Yangarra Resources July 2022, Investor Presentation)

Note that the level of indebtedness has shrunk to a much more comfortable level of bank margin. Many of the smaller companies that have committed to a production model from the initial lease acquisition and drilling optimization model have a very tight ratio of actual debt to bank liabilities. It’s about that rare company that can actually pay down its debt without having to make “deals” involving stock to get out of what was once considered a conservative level of debt before fiscal 2020 changed thinking. of the debt market on the conservative.

The other thing to note is that the assumptions are quite conservative given current price levels. This puts management in a position to continue to grow the business while (likely) reducing debt below guidance levels.

The company is not content to simply increase its production. But it does grow production to a fairly high level. A company of this size can sustain this growth rate for some time. But an investor would never know by looking at the major valuation ratios.

(Canadian dollars unless otherwise specified)

Yangarra Resource Operational Summary

Yangarra Resource Operational Summary (Yangarra Resources July 2022, corporate presentation)

Some of the costs vary with prices (such as royalty costs). But the key to the company’s profitability lies in the very low production costs combined with low depreciation costs. The costs shown above are much more typical of a natural gas producer than a company like this that produces oil, natural gas and liquids. The result is the additional value of the production stream compared to a natural gas producer which goes directly to the bottom line (with a very large profit percentage on revenue as a result).

Hedging activities have been a relatively small part of the company’s operations because production costs are so low. The result is that this business often achieves a net selling price that is much closer to the actual commodity price than is the case for many businesses that I follow. Profits are of course much more volatile. But again, the company reported profits in fiscal year 2020, when much of the industry lost a lot of money. Therefore, the additional risk of greater exposure to commodity price volatility is offset by low production costs.

(Canadian dollars unless otherwise specified)

Yangarra Resources Three-Year Cash Flow Outlook

Yangarra Resources Three-Year Cash Flow Outlook (Yangarra Resources July 2022, corporate presentation)

The only constant worry I see is that “prices will go down”. A slide like this should help investors see that if the company realizes the C$85 million cash flow estimated when WTI averages $90, then even if WTI slides to $70 million, free cash flow is basically back in about two years.

This assumption does not take into account ongoing technological improvements that continue to reduce costs (which would increase cash flow) and increase well productivity (which would also increase cash flow). As long as technology continues to improve, chances are the free cash flow projection for 2024 will turn out to be conservative.

In the meantime, this is a company whose production is rapidly increasing at a time when many others can only fix the company’s balance sheet while maintaining production. This growth in production, combined with continued advances in industrial technology, provides considerable downside protection.

Market concerns about debt will likely subside as the pace of debt repayment continues at an accelerated pace. There was a lot of fear in the debt market about industry debt at the start of this fiscal year. It is likely that the debt market will be a little less conservative as fiscal 2020 fades. But it also depends on economic management that can easily prevent the disasters of the two fiscal years 2008 and 2020 in the future. Another year like either of those two years would result in a much more conservative debt market, which is very counterproductive for growing companies.

Value of Yangarra Resource Pool per Share

Value of Yangarra Resource Pool per Share (Yangarra Resources July 2022, Investor Presentation)

In the meantime, there is a generous amount of (probably) highly profitable reserves behind each of the outstanding shares. The above average cash flow makes these reserves a much more viable proposition than if the cash flow is truly insufficient for the level of production. The active drilling program will likely revise this slide higher as the year progresses.

Note that management has announced a good number of wells starting at the end of the second quarter and the beginning of the third quarter. This likely means that the lull caused by the Canadian spring break-up is over. There seems to be a lot of production coming in time for the important heating season (this company produces a fair amount of natural gas). As a result, the next two quarters are expected to see a significant sequential improvement over the current quarter due to new wells coming on stream in the second half of the year.

It’s always hard to tell when a small company like this will attract the necessary institutional attention that leads to a higher valuation. But for those patient, buy-and-hold investors, the current price is likely to provide a rewarding entry level for a long-term investor. Management’s experience was evident when the company reported a profit in fiscal year 2020. This experience continues to show given the very low breakeven price of wells.

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