Athabasca Oil Stock: Buyout Opportunities (OTCMKTS: ATHOF)

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This article has been updated from the original article in my newsletter published on April 16, 2022 with current information.

Like many competitors, Athabasca Oil (OTCPK:ATHOF)(ATH:TSX) sees a chance to significantly reduce debt in the current environment environment. Thermal oil producers generally don’t have a good chance of surviving a downturn, as heavy oil and thermal oil producers generally see their margins disappear (or worse turn negative) as discounts on light oil products increase often.

So there is a huge need for adequate funding in the event of a downturn. This type of backup is usually available if the business has no debts or nominal amounts of debts.

(Canadian dollars unless otherwise specified)

Athabasca Oil, first quarter 2022, cash flow statement

Athabasca Oil, First Quarter 2022, Cash Flow Statement (Athabasca Oil, First Quarter 2022, Financial Statements)

Since the sharp drop in oil prices in 2015 i noticed that a lot of heavy oil producers didn’t make any money (and actually lost any money) for the period from 2015 to the start of the current price market very high oil. This kind of story only calls for diversification to ensure cash flow during periods of low prices.

Unlike many competitors, this company has a joint venture designed to increase light oil production. But like anything else, this joint venture needs time. Unfortunately, a crisis like the coronavirus demand destruction is not what this company needed. But management may be able to make up for lost time in the current context.

This will likely mean less growth. With a priority on debt repayment, it will also ensure the future survival of the business during these downtimes. Previously, management had weathered this latest downturn with a healthy cash balance. The stronger cash flow in the first quarter, combined with this cash balance, will likely restart the process of debt reduction from its previously moribund state.

(Canadian dollars unless otherwise specified)

Athabasca Oil Cash Flow Priorities and Directions Presentation

Athabasca Oil Cash Flow Priorities and Directions Presentation (Athabasca Oil May 2022, Corporate Presentation)

Thermal oil often requires a large upfront cash outlay to start the project. Once the project has started, the thermal oil often cashes in generously. Many times there will be plenty of cash flow even though there is not enough profit because the cash flow is protected by the relatively large amortization expense of taxes.

Now management has a chance to clear the debt balance over the next year. Ironically, the thermal oil may turn out to have higher margins than the light oil project. Management’s use of this extra cash from premium margins will be key to long-term survival.

Some competitors, such as Headwater Exploration (OTCPK:CDDRF)(HWX:TSX) have chosen to have a debt-free balance sheet. So far, Athabasca’s management seems to want a low-leverage balance sheet (ie a little riskier financially). Investors will likely see a variety of strategies from thermal producers and heavy oil producers to weather economic cycles going forward. Investors must choose the strategy that will work best for them throughout the economic cycle.

(Canadian dollars unless otherwise specified)

Athabasca oil plan will be debt free by year end

Athabasca Oil Plan to be Debt Free by Year End (Athabasca Oil May 2022, Corporate Presentation)

The current environment should lead management to quickly reach a negative net debt (or debt-free) position. It’s one of the few businesses I follow that still has a significant cash position while paying loan interest. It’s definitely a way to manage those assets. The company had around C$200 million in cash on hand throughout the pandemic (which is still going on). As debt is repaid, management may also reduce the cash balance.

One of the reasons for this cash position is that management had to shut down production in fiscal 2020 because prices were below the company’s costs. Light oil producers had cash. But a thermal producer like this must be prepared for periods without cash flow given the experience of recent years.

Athabasca Oil Light Oil Direction and Profitability

Athabasca Oil Light Oil Direction and Profitability (Athabasca Oil, May 2022, Corporate Presentation)

Light oil will provide a higher priced product that can reach the benchmark price (or at least come close to it). The property can also produce a significant amount of condensate needed to circulate thermal oil through pipelines.

Murphy Oil (MUR) operates part of the acreage while Athabasca operates the remaining acreage. The reason for the slow development at present is most likely the cost of the well. Murphy’s management has repeatedly mentioned that it will take some time to find the optimal technique.

Both operators want the low breakeven costs to serve as a minimal margin cushion. This is meant to be a cash flow generator during downturns. But the costs don’t seem quite there yet.

The goal would be hugely important to offset shutdowns in the thermal sector when things get more hostile than they are right now.

Debt must be repaid whether or not the business generates sufficient cash flow to properly repay it. Athabasca Oil has already built and sold the business. Most likely, management believes that the current challenges can be overcome, otherwise they would never have invested in this area.

Summary

Athabasca Oil has weathered the coronavirus demand destruction admirably when you consider it is a stand-alone thermal producer. Much of the output from the thermal industry is tied to an upgrader or refineries all owned by the upstream company. A stand-alone model such as this is not really common as margins often widen to render production worthless.

Management has partnered with Murphy Oil to add light oil production to thermal generation. This should lead to greater resilience during downturns than has been the case with recent history.

Management will also reduce debt while trying to maintain a healthy cash balance “just in case”.

Some feel that a company like this should have the same value as light oil producers. But the market relies heavily on average profitability throughout the cycle. This calculation makes the light oil sector all the more important. As a rule, stand-alone thermal and oil companies are not so profitable.

As this business grows, management may well consider the possibility of acquiring a valuer close to the upstream operations. Such a possibility would lead to improved bottom line revenue through vertical integration. Right now, it’s the light oil sector that needs sufficient cash flow to weather the industry downturn.

The growing margin of ever-increasing light oil production can lead to better valuation over time. But this investment idea will require a lot of patience as the time frame is likely to be a few years. This makes the common suitable for speculators until the debt is reduced or (preferably) eliminated.

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