(Idea) Strathcona Resources Q2 Update

Note: Dollar references in this article are to Canadian dollars unless otherwise noted.

Strathcona Resources (SCR:CA) reported second-quarter earnings yesterday after the close. All in all, the results were in line with expectations, both ours and analyst consensus. The highlight of the quarter was the company having reached its net debt target and its associated capital allocation policy shift.

The stock market’s verdict on the results was positive. SCR shares are up 4.0% today as WTI is down 1% and XEG, the Canadian E&P ETF, is up 0.8%.

Cash flow results were also in line with consensus expectations. The company generated $2.56 of funds from operation per share versus expectations of $2.58. Capex for the quarter was $298 million, below consensus expectations of $340 million.

Production in the second quarter came in at 181,766 boe/d—78% weighted toward liquids—slightly lower than the 185,122 boe/d produced in the first quarter. The quarter-over-quarter decline was attributable to SCR having shut in natural gas production in response to low natural gas prices. It currently has some highly productive natural gas wells in its Groundbirch acreage that management has opted to shut in pending stronger gas pricing. These wells will rapidly boost companywide output once they are brought onto production.

It is also deferring some Groundbirch wells planned for later this year. The production impact of the deferral caused management to reduce its full-year 2024 production guidance from 190,000 boe/d to 187,500 boe/d. The revised guidance—shown below—does not change our appraisal of SCR’s value or its long-term prospects.

Source: Strathcona Resources Q2 2024 Management’s Discussion & Analysis, Aug. 14, 2024.

The company generated $247 million of free cash flow during the second quarter, in which WTI averaged US$80.55 per barrel. The quarterly result equates to $988 million of annualized free cash flow, in line with our previously stated expectation for the company to generate approximately $1 billion of free cash flow per year at US$80 per barrel WTI.

SCR allocated $198 million of second-quarter free cash flow to paying down long-term debt. The debt repayment brought the quarter-end net long-term debt balance to $2.4 billion, below management’s target of $2.5 billion.

Distributing Free Cash Flow to Shareholders

Having met the target, SCR has pivoted to paying out significant sums of its free cash flow to shareholders.

As expected, SCR’s first capital allocation policy shift was to declare its inaugural quarterly base dividend, which is set at $0.25 per share. The $1 per share annualized payout is equivalent to a 3.1% dividend yield on the current $32.00 share price. If the dividend had been paid in the second quarter, it would have represented 21.4% of free cash flow, indicating substantial free cash flow coverage. We believe the base payout can be funded from free cash flow down to US$67 per barrel WTI.

In SCR’s second-quarter earnings conference call, management elaborated further on capital allocation. It affirmed its intention to pay out all of SCR’s free cash flow that isn’t allocated to acquisitions in the form of a base dividend combined with periodic special dividends. It currently expects to pay the special dividends once or twice per year.