Tourmaline Oil (TRMLF): A Buying Opportunity

Tourmaline Oil Corp. (OTCPK:TRMLF) announced on January 12, 2023 that it has revised its production target downward, from 545,000 boe/d to a range of 520,000-540,000 boe/d, and has also revised its capital budget upward due to higher inflation expectations. The market responded negatively to this news, causing the company’s share price to drop by more than 3%, although Tourmaline declared a C$2.00 per share special dividend.

This negative sentiment is a continuation of the short-term bearish trend that has been ongoing since December 2022, during which the stock has declined by 19%.

It is, therefore, a great time to review whether the business fundamentals have changed for Tourmaline. If the long-term outlook remains bullish, the recent share price weakness should be viewed as a buying opportunity; otherwise, shareholders should move on.

Tourmaline overview

Tourmaline is the largest natural gas producer in Canada, having produced 2,240.64 MMcf/d of natural gas and 108,457 bbl/d of crude oil condensate and NGLs in 3Q2022, with gas accounting for 77.5% of the total production. The company is also the fourth largest gas processing midstream operator in the country (Fig. 1).

Tourmaline’s production is supported by 4,243 MMboe of proved and probable reserves, which are composed of 19.5 Tcf of natural gas (76.5%) and 995 MMbbl of liquids (23.5%), as indicated in Table 1. The company’s 2P reserve life is estimated to be 22 years. Additionally, Tourmaline estimates that it has a substantial 75-year drilling inventory across three plays, namely the Alberta Deep Basin, the Montney, and the Peace River High (Fig. 1).

• Owning such a substantial drilling inventory implies that Tourmaline can expand its reserves organically through further drilling, while incurring a low unit cost of finding, developing, and acquiring (FD&A) of approximately C$4.54/boe. It also suggests that the company does not have to acquire costly resource additions in the market.

The size of Tourmaline accords the company a slew of advantages over its peers, including access to lower-cost capital (2022 aggregate effective interest rate at ~3%), bargaining power with oilfield service vendors, and being the preferred natural gas supplier for LNG liquefaction terminals. For example, Tourmaline secured a long-term gas supply agreement with Cheniere Energy, Inc. (LNG) to supply 140 MMcf/d of gas under Japan Korea Marker (or JKM) pricing beginning in early 2023.

Additionally, Tourmaline continues its Conroy North Montney development, and is poised to supply gas through the Coastal GasLink pipeline of TC Energy Corp. (TRP) to the Shell plc (SHEL)-led LNG Canada liquefaction plant in British Columbia. Coastal GasLink was >80% complete and LNG Canada >70% complete as of year-end 2022, seemingly on schedule for 2025 commencement of operation. At 100,000 boe/d capacity, Conroy North Montney brightens Tourmaline’s growth outlook in the near term.

Profitable growth, dividends

Since founding Tourmaline in 2008, CEO Mike Rose has set an ambitious goal for the company. As he allowed,

“Our goal is to control the largest, lowest-development-cost, lowest-emissions natural gas supply in North America.”

Tourmaline has consistently progressed towards its goal, as demonstrated in Fig. 2. Currently, the company is the fifth largest natural gas producer in North America, behind EQT Corp. (EQT), Southwestern Energy (SWN), Chesapeake Energy (CHK), and Coterra Energy (CTRA). The company aims to grow production to 700,000 boe/d by 2028, with a projected compound annual growth rate of 5.5% over the next six years. Its 75 years of drilling inventory in three emerging plays in the richly-endowed Western Canadian Sedimentary Basin positions the company to potentially surpass its U.S. competitors that operate in maturing shale gas plays.

As production increased, economies of scale were achieved. This can be demonstrated by the improvement in capital efficiency and decrease in unit G&A costs as shown in Fig. 3.

Thanks to increased cash flow and improved capital efficiency, free cash flow grew substantially, as depicted in Fig. 4. Tourmaline consistently raised basic dividends and, since 4Q2021, paid generous special dividends to shareholders. In 2022, the company paid a total of C$7.90 in dividends to every share held since the beginning of the year, with an implied dividend yield of 19.2%. It is projected that in 2023, Tourmaline will likely pay C$1.16 basic and C$8.00 special dividends to every share held since the beginning of the year, resulting in a 13.7% yield and 16.0% dividend growth rate.

Valuation, risks

Tourmaline, with an EV/EBITDA multiple of 2.85X on a trailing 12-month basis, is undervalued compared to the top four U.S. gas producers (whose multiple ranges from 3.16-4.30X) despite its lower debt leverage and stronger growth prospects. Valued at 1.81X 3Q2022 EBITDA on a run-rate basis, Tourmaline is undervalued compared to its industry peers.

Tourmaline’s stock is currently trading at US$7.65/boe of 1P or US$3.94/boe of 2P reserves, or at 0.88X of its proved and probable NAV. These metrics are based on 2021 year-end reserve data, and it is expected that when the 2022 year-end reserve data is released in March 2023, Tourmaline will be found to be even more undervalued. Furthermore, these metrics do not take into account the hydrocarbon resources present in the company’s large drilling location inventory or the value of its significant midstream assets, making Tourmaline even more undervalued in comparison to its assets.

The main risk for Tourmaline is the ongoing negotiations between the British Columbia government and Treaty 8 First Nations regarding northeastern British Columbia. While it is expected that an agreement will be reached in 2023, any delays could impact the Conroy North Montney development of Tourmaline. Additionally, while the Coastal GasLink pipeline and LNG Canada projects are in the advanced stages of construction, there is a risk that they may not come online as scheduled.

I am not concerned about the volatility of natural gas prices as Tourmaline has an extensive hedging program. Their properties have high FCF margins, providing resilience for the company (Fig. 5). In 2020, when natural gas prices dropped significantly, the company still generated enough FCF to cover dividends (Fig. 4).

Mike Rose, the founder and CEO of Tourmaline, has been regularly acquiring a significant amount of the company’s stock in the public market for several years, with his most recent purchase taking place in January 2023. The insiders, including Rose, currently hold ~6% of the company’s stock, which represents a significant investment in the C$23 billion company. It can thus be inferred that the interests of the management are closely aligned with those of individual investors.

Investor takeaways

Tourmaline Oil is a top-performing natural gas producer, with high-quality assets and high-margin profitability. Its strong potential for organic growth, backed by a vast inventory of drilling locations, positions the company to become a leading producer in North America.

With its stock currently undervalued, it presents an attractive opportunity for both investors seeking high dividend yield and those bullish on Canadian natural gas in the medium to long term, especially with the recent dip in stock prices (Fig. 6).

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.