Tamarack Valley: Have Recent Acquisitions Set the Company Back? (OTCMKTS:TNEYF)

(Note: Tamarack Valley is a Canadian company and reports its results in Canadian dollars unless otherwise noted.)

Tamarack Valley (OTCPK:TNEYF) reported a small loss in the latest quarter. This was despite strong progress in many fronts according to the latest quarterly reportsThis undermines the company’s strategy of growth through acquisition.

In my last article, I noted that acquisitions created a significant stake in the company, as it used the stock from those acquisitions to quickly grow to its current size in terms of production. But when the company now reports a loss, legitimate questions about strategy arise.

Meanwhile, competitor Headwater Exploration ( OTCPK:CDDRF ), which is growing organically, has seen net income come in at about 25% of revenue. Its latest acquisition, Tamarack Valley, recently closed on fiscal 2022 at the end of (and it was very significant). Today, Headwater Exploration’s organic growth is much easier to interpret, while Tamarack Valley’s earnings have a lot of acquisition-related expenses. This includes “step-up” expenses, since acquisitions were likely a premium to organic growth of acquired properties. Over time, which company will come out on top is still a subject of much debate.

Profits

The loss that Tamarack Valley reported was due to a write-down on derivatives and an impairment charge related to the disposal of certain assets, both of which are non-cash. There would also be some closing costs.

Compared to Headwater Exploration, Tamarack Valley also has debt service costs that Headwater Exploration doesn’t have to worry about. The latter is a cash cost and is a competitive disadvantage for now.

To be honest, the earnings trend and cash flow trend are not very encouraging across the board in terms of acquisition strategy. This is partly because the company made acquisitions after commodity prices peaked in fiscal 2022. So, it would be difficult to compare operational progress when commodity prices are trending lower.

Nevertheless, it is clear that management now needs to demonstrate the merits of its chosen strategy.

While net debt is currently within an acceptable range, heavy crude oil is a discounted product that has seen its discount widen many times in the past. The widening discount has often turned heavy oil production into a negative cash flow position (to the point where production is shut down) until the next cyclical price recovery begins. This makes what looks like an acceptable debt balance (currently) somewhat riskier than its light oil peers.

Competitors producing heavy oil like Headwater Exploration have no long-term debt and a healthy cash balance for the very reasons stated in the last paragraph.

As a result, there will likely be quite a lot of pressure to significantly reduce the debt balance in the near future. Therefore, shareholder returns will take a “second place” to financial initiatives.

Heavy Oil Profitability

One reason for the rapid growth through acquisitions was the profitability of the Clearwater Basin, as shown below:

In the current pricing environment, Clearwater Play has virtually unmatched profitability. It should be noted that the company is receiving two returns in about one year. This of course compares favorably to Permian drilling, which can pay for itself twice in a “period” in some cases. Over the comparable time period shown above, Clearwater Play with heavy oil pays for itself 5 times.

This means that in the given time period, the company can drill five wells with the same capital. If we consider that the same calculation applies to five wells drilled, the current environment allows for a very rapid build-up of cash flow.

Management may be counting on cash flow to quickly handle the debt burden. However, it should be noted that the time frame shown above is approximately 5 years. During this period, management needs the cooperation of commodity prices. This may be far from a certain assumption.

Still, Clearwater’s characteristics make an acquisition strategy seem very tempting.

Light Oil Profitability

Light oil production is a premium product that will generally generate cash flow during cyclical commodity price declines. As a result, management can rely on this production to service debt during declines.

Any time a well produces 200,000 BOE, which is mostly light oil, in less than two years, that well is probably a very profitable producer. The wells shown above are mostly oil, so the production mix is ​​a very profitable mix.

The company’s strategy could be to use some of the cash generated by its highly profitable heavy oil production to generate cash flow that could service its debt during a recession. This would be a “race against time” because there is currently not enough light oil to meet that requirement. However, as debt is paid down and production increases, the situation may change, depending on how long it takes for the next cyclical downturn to occur.

There is an obvious strategic trade-off between light oil, which is not as profitable as heavy oil, but light oil that will provide cash flow during periods of cyclical economic downturns, and heavy oil that has suspect cash flow during periods of economic downturns.

summary

Tamarack Valley Energy management decided to let others take the risk of exploration and production in a relatively new basin. In exchange for that risk, management was willing to pay a price for established production combined with decent reserves. Therefore, Tamarack Valley Energy shareholders likely have a higher cost of production (combined due to the acquisition strategy) but less risk upstream than the original competitors who sold the company acreage and production.

The stock price has not really gone anywhere since its peak in fiscal 2022. Therefore, the “buying spree” has not yet yielded any benefits. Furthermore, the debt burden is riskier, especially for heavy oil producers, who often see their cash flows disappear during cyclical commodity price declines.

Now, whether the company has the space and strategy to leverage the entire package that has been prepared is a matter of course. Readers will have to form their own opinion on this.

The buyer will reportedly be buying the best geology, which may allow for overall better performance compared to others in the same basin. In addition, the Clearwater basin is fantastically profitable. Therefore, in the long run, the properties acquired should prove to be very valuable.

One of the things that supports this strategy is periodic technological leaps that allow for reporting better operational results over time. Therefore, this management strategy has many advantages.

Still, the debt load and acquisitions make it a speculative purchase consideration. Management needs to demonstrate the superiority of its strategy over time. That hasn’t happened yet.

Risks

Every upstream producer is subject to low visibility and commodity price volatility. The strategy here requires favorable commodity prices for probably at least 2 years. There is no guarantee that this will happen.

Rapid growth carries its own risks. This company has grown through multiple acquisitions and now has to demonstrate that all of those separate parts will work well together. This board has the experience to probably mitigate all of those risks.

The real question is whether the market is running out of patience. So how long do investors have to wait for those higher returns promised by this strategy?

Debt must be paid down quickly to much lower levels. There is no guarantee the company will have time to do this before the next cyclical decline begins.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.