Yangarra Resource Stock: Adjusting to Reality (OTCMKTS: YGRAF)

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Discovery and Development (F&D) Costs for Yangarra Resources (OTCPK: YGRAF) will be adjusted this year because the company finally has a 5-year production history. Adjustments like this always raise concerns because a one-time adjustment often skews five-year average figures and can obscure production progress being made. Often, when management determines that certain leases are commercially productive, underlying work is required to optimize production as well as upfront infrastructure costs that are unlikely to recur in the future.

The adjustment noted in the initial announcement did not result in in a year-end charge. In fact, the company posted one of the best annual results in its history. Changes in assumptions like this often affect later production years and often involve low amounts of reserves (and production far into the future). Thus, the lack of charge is not surprising.

Therefore, it is wise to consider current costs and cash flows as a guide for the future. Unless the technology “shuts down”, cost and production optimization will continue to improve in the future. These adjustments to reality often reflect a fair amount of cost that will not be repeated in the future simply because management has learned so much about the geology and what works best.

(Canadian dollars unless otherwise specified)

Profitability and Production Characteristics of Yangarra Resource Wells

Profitability and Production Characteristics of Yangarra Resource Wells (Yangarra Resources March 2022, corporate presentation)

Current wells seem extremely profitable. There can be many things that could go wrong. Yet these wells are still worth drilling. The best part about these sinks is that they pay back in less than a year. Therefore, management can drill two wells with the same capital in one fiscal year to generate cash flow quickly.

As long as current commodity prices remain close to their current selling price, this company will likely complete its transition to mining mode by achieving a level of production that allows for both debt repayment and production growth. . In fact, the management has already begun to repay its debt while increasing its production. Currently, very high commodity prices will certainly accelerate the original plan.

Management appears to be drilling some wells faster than expected. This benefits the large natural gas production by selling the high initial production natural gas shown above during the high priced heating season. Such a strategy could increase the rate of return of newly drilled wells by a few percentage points.

Management has already noted that cash flow has improved to C$32 million so they can afford to spend C$27 million on increased production. More so that the new level of cash flow reduced the key debt ratio to 1.5. This level of leverage is a pretty decent ratio in the industry. Management aims to bring this ratio down to 1. The current high price environment could bring the company to this point much faster than the market expects.

Management previously approved a capital budget of C$105 million. This spending direction is a bit more uncertain as service costs rise with the industry’s continued recovery. Many companies, including this one, will likely offset rising service costs (at least partially) with operational and well design improvements. Currently, cash flow is expected to be C$165 million for fiscal 2022. This would pay off a good portion of the debt while increasing production by about 20%.

So many companies report their debt to EBITDA. This company reports a much more conservative debt-to-cash ratio. This can sometimes confuse the market as to the actual prudence of the above ratio. Personally, I prefer to use cash flow from operating activities because it’s the money available for really everything. EBITDA is sometimes far from estimating the cash available to spend (especially for growing companies where working capital absorbs part of the cash generated).

(Canadian dollars unless otherwise specified)

Yangarra Resources Summary of Operations for the Fourth Quarter of Fiscal 2021

Yangarra Resources Summary of Operations for the Fourth Quarter of Fiscal 2021 (Yangarra Resources, Fourth Quarter 2021, Earnings Press Release)

Regarding future expensesit is extremely important to note that it is one of the very few companies in the sector to have declared a profit in the financial year 2020. Even powerful Exxon Mobil (XOM) lost money in fiscal 2022. This profit reported by Yangarra was supported by an appropriate level of cash. This company has reported profits every year since drilling began. In this industry, I follow very few companies with five (or more) years of profit. It was a brutal time for the industry.

In fiscal year 2020, many companies I followed bled a good amount of cash even after hedging activities. The casualties were horrific. The achievements shown above point to above-average profitability regardless of the adjustments needed this year, now that the company has a five-year history.

Yangarra Resources Lease Assets Map

Yangarra Resources Lease Assets Map (Yangarra Resources March 2022, corporate presentation)

The company was a pioneer in the bioturbated area in the Ferrier and Willesden Greene areas. Now all 136 sections are located in an area that has been producing for a long time. It is the interval that is unique to this company and the reason for the lack of records when calculating operating reserves and production parameters.

Management continues to report extremely low costs that are at the producer level of higher percentages of natural gas production. It is also a sign of higher profitability. It also helps that natural gas prices are currently higher than they have been in years. But the variety of production from these wells allows the company to be profitable under a wide variety of production scenarios.

The inventory cited above is based on knowledge gained from current drilling. Many pools in Canada (including this one) have other ranges that could offer future upside potential once the company completely depletes current inventory. Management buys yet another section from time to time to increase the available inventory of the known area.

This business (like many small businesses I follow) was busy increasing production from nothing to an acceptable level that would allow for growth and debt repayment. Obviously, the challenges of the coronavirus have interrupted this process. However, this company was also more advanced with a higher level of production than many small companies I follow. This allowed management to increase production while modestly repaying the outstanding loan.

Current conditions allow management to return to the original strategy of achieving this desirable level of production. Once debt ratios also reach desirable levels, management will likely launch a dividend, possibly with a share buyback program. The profitability of the well gives this company a significant competitive advantage which has manifested itself in fiscal 2020. Going forward, increased production will likely result in more cash flow and profitability than expected. the market. This company is therefore very likely to attract institutional attention as it grows (and therefore higher valuations).

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