Hemisphere Energy (HME:CA): A debt-free balance sheet creates opportunity

North American oil

mystical energy

an introduction

I’ve been keeping tabs on Hemisphere Energy (TSXV: HME: CA) (OTCQX: HMENF) as it is one of the smaller producers in my portfolio. While I am usually not a fan of small producers only A few thousand barrels a day in oil production (where a small problem can have a big impact), the Hemisphere has performed well this year although the production results are a bit lower than I expected. But on the other hand, the debt-free product offers an attractive dividend yield and I don’t see any reason to sell.

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Free cash flow in the third quarter enabled Hemisphere to pay off all debts

During the third quarter, Hemisphere Energy produced just under 2,900 barrels of oil equivalent per day, of which 99% was heavy oil. This is a bit lower than I expected as Hemisphere revealed an average daily production rate of over 3,000 boe/d in July. It received an average price of just C$90.39 per barrel of heavy oil (not surprising as heavy oil trades at a discount to light oil) while natural gas was sold at an average price of just under C$4 per cubic foot. This resulted in a net realized price of 89.66 Canadian dollars per barrel of oil equivalent.

production data

Investor Relations in the Energy Hemisphere

As the royalty rate moved in tandem with the price of oil, average royalty payments per barrel of oil-equivalent also decreased, but unfortunately net operating expenses increased on a per-barrel basis, resulting in a net recovery of CA$49.95 per barrel of oil-equivalent and about 47.17 Canadian dollars after taking into account the effect of hedging operations.

Total revenue was approximately C$23.7 million before royalty payments were taken into account, and net revenue, including realized and unrealized hedging losses and gains, was C$19.6 million. This resulted in an operating income of C$12.3 million, including approximately C$2 million in depreciation and depletion expenses.

income statements

Investor Relations in the Energy Hemisphere

Because the Hemisphere had very little debt, interest and financing expenses were also very low, which is why pre-tax income is almost identical to operating income. After deducting tax expenses, the attributable net income was CAD 9.3 million which translates to earnings per share of CAD 0.09. Keep in mind that this includes about CAD 2.3 million in unrealized gains and this obviously boosted pre-tax income by the same amount. Excluding that unrealized gain, the EPS would have been around C$0.07 which obviously is still a good result.

As you can see on the income statement, the majority of income tax is “deferred.” Hemisphere still had access to just under C$55 million in tax collectors when the year began, but a strong result in 2022 has reduced that available and the company will likely start paying all taxes in the very near future.

The collapse of the tax pool

Investor Relations in the Energy Hemisphere

But during the third quarter, the majority of taxes were still deferred which helped boost operating cash flow. The reported cash flow was C$10.6 million and after deducting C$149,000 in rental expenses, adjusted operating cash flow was C$10.5 million. This includes CAD 0.7 million in unrealized hedge losses but excludes CAD 3 million in hedge gains and CAD 2.3 million in deferred taxes.

Statement of cash flows

Investor Relations in the Energy Hemisphere

Total capital expenditures for the quartet were approximately CAD 4.6 million, resulting in an adjusted free cash flow result of approximately CAD 6 million. With just over 103 million shares outstanding, free cash flow per share came in at just under C$0.06.

And as you can see above, the majority of the free cash flow was used to pay down debt and Hemisphere ended the third quarter with a net cash position of a few hundred thousand dollars (excluding lease liabilities and decommissioning obligations). This is good news because it also means that the CAD 0.15 million in interest expense incurred in the third quarter will not appear on the income statement.

It also means that the quarterly dividend of C$0.025 per share is well covered by cash flow, as the company only needs about C$3 million each quarter to cover the dividend.

The company plans to maintain its capital expenditure program at approximately C$4 million per quarter for a full year share of C$16 million. Unfortunately, Hemisphere hasn’t given guidance for next year yet, but I would expect similar numbers with a free cash flow result of about C$30 million at $85 WTI.

Sensitivity analysis

Investor Relations in the Energy Hemisphere

The company still has some hedges but it should not have a significant impact on the financial performance.

hedge book

Investor Relations in the Energy Hemisphere

investment thesis

I have a small long position in Hemisphere Energy and see no reason to sell. The company is now debt-free, and while I generally don’t like small producers with output of a few thousand barrels a day, I’m okay with being exposed to the Hemisphere. The current dividend of CAD 0.025 per share per quarter and CAD 0.10 annually gives me a 7% dividend yield while Hemisphere applies a 30% payout rate.

I look forward to seeing the more detailed plans for 2023 and the year-end reserve statement.

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