(Idea) Kelt Exploration - A Potential Acquisition Target
Note to readers: Dollar values are in Canadian dollars unless otherwise noted.
The M&A market for Canadian E&Ps is heating up. We see several good reasons why this trend is poised to continue.
There are too many Canadian E&Ps. While many of the junior E&Ps that existed ten years ago are gone, there are still too many sub-scale operators. Over time, unless these companies intend to grow their production at a high rate, such as Headwater Exploration (HWX:CA) and Logan Energy (LGN:CA), they are likely to be bought out.
Another way to view the existence of “too many” E&Ps is to view the entire sector as one single E&P. What becomes clear is that G&A costs per barrel across the industry are too high. In a capital-intensive, cyclical business with depleting assets such as oil and gas exploration and production, maximizing profitability per unit is the name of the game. As the sector matures, achieving this goal entails eliminating excess G&A costs through consolidation. We therefore expect consolidation in the Canadian oil patch to continue for the foreseeable future.
There are several active consolidators. The foremost consolidators at the moment are Tourmaline (TOU:CA) in the natural gas space and Strathcona (SCR:CA) in the oil space. Both have signaled their intentions to consolidate their respective spaces over the coming years.
Moreover, both seek to consolidate through counter-cyclical expansion, meaning that they intend to acquire properties and companies when commodity prices are low to harvest the cash flow when prices are high. On a long-term basis, we believe both oil and natural gas prices are low, creating the potential for accretive deals for acquirers.
A Prime Acquisition Target: Kelt Exploration
Kelt Exploration (KEL:CA) is at the top of the list of E&P acquisition candidates qualifying as “sub-scale.” The company has an unusually large asset base relative to its ability to finance development. Kelt’s proved reserves span 16 years, while the company estimates that it has a multi-decade inventory of high-return drilling prospects.
Furthermore, Kelt’s assets are high quality, featuring low breakeven prices per unit and offering significant cash flow torque to higher commodity prices.
These characteristics can make Kelt's assets particularly desirable to an acquirer.
Kelt’s proved reserve net asset value amounts to $10.37 per share, significantly in excess of its current $6.25 share price. PDP reserve net asset value per share is $3.87. A comparable gassy E&P that recently put itself up for sale, Crew Energy (CR:CA), accepted an offer that was 74% above its PDP net asset value per share and 10.0% below its proved reserve net asset value per share. Basing a Kelt buyout offer on Crew’s offer vis-à-vis proved reserve net asset value, Kelt would be offered $9.47 per share in consideration, which would represent a 51.5% premium to its current stock price.
Kelt’s production is split 65%/35% natural gas/liquids, and is focused in the Montney in Alberta and British Columbia. Its operations are in a currently “hot” area that features top-tier economics among North American light oil and condensate-rich gas production.
Source: Kelt Exploration August 2024 Investor Presentation.
The main roadblock to executing a deal with Kelt is the necessity of management’s buy-in. Management collectively owns 18% of Kelt’s shares currently outstanding. It has a long track record of success and is highly regarded by its shareholder base—rightfully so. Its approval will therefore be necessary for any deal to get done.
On the other hand, management’s control makes it more likely that if it wants to sell or if it receives an offer that it believes to be attractive enough to gain its consent, a deal will happen. Such a deal could take the form of asset sales or an outright sale of the entire corporate entity.