Surge Energy (SGY.TO and ZPTAF) Update - Sept 14

[dan_s]

Note from one of our good friends in Calgary.

Surge Energy – SGY – T <<< Trading at $9.53Cdn when this was posted.
Market Cap ~$950M/~EV ~$1.26B
Net debt ~$311M
Shares outstanding 98.3 million
30day avg trading volume 2.8M
Current production ~24,000 Boepd in Q3, expected to increase to 25,500 Boepd by year-end

· Surge management is both adept at M&A with an enviable land base and superb technical team.

· Maintenance Capex $175M which will deliver $335M in CF @ $80WTI and an Exit rate of 25kbeopd 87% levered to oil (highest in their peer group) more than half of their production receives WCS pricing. Given the extreme distillate shortage, we expected differentials will remain tight and only get tighter heading into winter, benefiting the price they receive for their crude.

· $160M FCF (pre divy) and a 66% payout ratio will enable them to continue to improve their balance sheet, increase their dividend from $0.48/year, paid monthly and/or add a buyback or add a modest growth wedge.

· PDP NAV increased by 107% from $3.51 to $7.28 1P Value of $13.72/share and 2P NAV of $22.37 < My current valuation is $15Cdn/share.

Recent Milestones & Catalysts

· The Company plans to have two rigs drilling in Sparky and one in SE Sask. These two areas offer some of the best economics in the basin, just behind Marten Hills and Clearwater.

· in 2022 they also made two new pool discoveries and in Q1 a new discovery at Cadogen drilling two wells which have a combined average production of 390 boepd which adds 32 new locations.

· Their Steelman light oil pool extensions added > 40 top tier drilling locations.

· They acquired 20 net sections in their heavier region of the Sparky where they are just completing their first 12 leg open hole completion technique well. They believe the play extends on the entire land position and the new completion technique could be a game changer drilling the heavier halo. < Multi-leg open hole completions are a "New Thing" in Western Canada and well results have been impressive. These wells tend to come online at high rates and establish decline curves above the pre-drill type curves, so Surge should get more P1 reserves added.

· We should also have some exciting news from Midale and Steelman areas.

· SGY has 3Billion BOIP which is only booked to recovery factor of 11.5%. Most of their core areas will deliver 20% on primary 35% recovery with water flood. Undiscounted, every 1% change in recovery factor will add $1BIL in NPV.

· They have 1050 drilling locations with only 550 booked in their 2022 reserve report with 13 years of drilling inventory. 650 of those locations pay back in less than one year. < The main reason that I added Surge to the Small-Cap Growth Portfolio is the Company's large high-quality running room.

· They are one of the few companies left with an enviable tax pool position of $1.4B.

KEY Highlights

· Estimated cashflow $335M and $160M of FCF before dividends. < This new estimate of operating cash flow compares to my recent forecast of $274.7Cdn million.

· 87% levered to oil is the best company in the mid-tier group to benefit from tightening supply for both light and WCS pricing and higher oil prices.

· Sensitivity – Every $1 change to WTI adds $8.7M in cashflow therefore at $90 WTI cashflow increases to ~$420M

· Next dividend increase will likely be implemented when they meet their next debt target likely Q4 2023. (Paying down $100M debt in 2023)
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