In November I wrote an article on Gear Energy (OTCQX: GENGF) where I decided to go long, but explained that the stock seemed like a good idea to consider for investors who believe in a $75 oil environment that will last for a while. Not only has that $75 barrier been hit, but the price of WTI oil has been trading above $80 a barrel for some time now, so maybe it’s time to catch up with Gear Energy and sharpen expectations for 2022.
Gear Energy currently has 259 million shares outstanding, giving it a market capitalization of approximately C$270 million using the current share price of C$1.04 (the share price is trading almost at the same level as when the November article was published). The company’s Canadian listing is much more liquid than the US listing and I would strongly recommend trading the company’s securities using its listing on the TSX. the Gear Energy’s stock symbol in Canada is GXE. Average daily volume exceeds 1.6 million shares.
Monthly updates provide great insight into how the business is run
Unlike most other oil and gas producers who only provide information to their investor base on a quarterly basis, Gear Energy provides a monthly update. These monthly updates contain the month’s production results, cash flow and capital expenditures, along with a brief commentary. This is very useful information for investors because it allows a much more precise follow-up of the company’s performance compared to seeing the results every three months.
Gear has released its December update, which also means we now have a pretty detailed idea of how Q4 has been for Gear. As you can see in the image below, October and November started well but December was quite a weak month.
In December, the company had to deal with a lower WTI benchmark price, and the effect of a higher oil price differential further increased the impact. Moreover, the production was also lower. While Gear Energy was producing over 6,500 boe/day in November, this fell to just over 5,700 boe/day due to very harsh weather conditions. The December update contains a graph in which Gear Energy’s oil production was compared to temperature changes. These are “absolute” temperatures and do not take into account wind chill.
I’ve had a few winters in Alberta in the past and when the official temperature is, say, -30 degrees, even a tiny bit of wind makes it much colder. So yes, I understand and accept that temperature can be a reason why operations can be a bit less efficient.
Going back to the monthly update, despite these setbacks, the company is still generating operating cash flow of C$4.3 million and since only C$0.9 million was spent in capex, the cash flow free cash remained positive at C$3.2 million, further reducing net debt. to 16 million CAD at the end of December 2021. This is a very aggressive reduction from the 53 million CAD at the end of 2020 and the almost 28 million Canadian dollars at the end of T3. Total free cash flow for the entire fourth quarter was approximately C$12 million.
What does this mean for 2022?
This now allows us to determine what Gear Energy will be able to deliver in 2022. In November 2021, the company mentioned that it would be spend C$40 million in capital expenditures which should result in an increase in average production to 5,900-6,000 boe/day, approximately half of which is heavy oil.
According to the company’s official forecast, an oil price of US$75 on a WTI basis would result in a free cash flow result of C$41 million. Spread over 259 million shares, that’s just under C$0.16 per share. A WTI oil price of $80 would translate to approximate free cash flow of C$50 million or C$0.19 per share.
While funds from operations were just C$17.9 million in the fourth quarter, it’s easy to see why the full-year guidance is C$81 million (or roughly 20 million Canadian dollars per quarter). First, the 2022 guidance uses a WCS differential of US$14/barrel slightly lower than in the fourth quarter. More importantly, as Gear Energy rapidly reduces its net debt and will likely be debt free by summer, interest charges will drop to zero, which will also increase cash flow. During this time, the cover book also takes place and Gear Energy will be able to enter into derivative contracts which should guarantee a higher price received.
This is important because, for example, the third quarter operating cash flow of C$16 million at $70 WTI included almost CA$3M of realized hedging losses. It is therefore not difficult to understand where the quarterly cash flow of 20 million Canadian dollars per quarter will come from.
My decision not to invest in Gear Energy was the right one in November. As the price of oil has continued to rise, Gear Energy’s stock price is currently trading 2% lower than two months ago. While an investor wouldn’t have lost any money, the opportunity cost of missing out on the moves of other oil names would have been tough.
The last three months have been interesting and it might be an option to spin some of the other oil exposure at Gear Energy. Trading at just over 5x free cash flow at US$80 WTI means Gear Energy isn’t materially cheaper than its competitors, but now that the balance sheet has been cleaned up, Gear might start thinking about what it will spend its money in the second half of 2022, as Gear forecasts net cash above C$0.10 per share by the end of this calendar year.