Baytex: Bullish bet on oil

by Lou Gagliardi, editor Cabot Global Energy Investor

My latest featured stock pick is Baytex (BTE), a leading Canadian heavy-oil producer with an exceptional dividend to provide downside share support in a rocky market.  

Geopolitical tensions, i.e. Iran, continue to rear its ugly head and reinforce our bullish outlook for crude prices and the energy sector.

Here is the short list of why we are bullish on Baytex:

• High dividend at 4.30% – beats historically low bond yields as well as providing downside support in anotherwise volatile commodity price environment
• Growth stock – BTE has grown at a compound quarterly growth rate of 11.5% over the last three years (1Q09 to 4Q11)
• Low political risk – Canadian exploration and production company (E&P)
• Moderate exploratory risk – heavy oil producer operating in existing producing areas
• Close proximity to high consumption/demand markets – the U.S.
• Technical indicators are bullish
• Bullish tailwind of long-term higher crude prices

Last September, I met with the management team of heavy oil producer Baytex Energy in Calgary, Alberta, and I liked what I saw.

BTE is a mid-cap (C$6.9 billion) E&P that intends to grow production, as well as its dividend.

Even though Baytex is signifi cantly weighted to oil in its production profile — 84% of total production and 91% of reserves are oil — I think the company is an exceptional performer in the energy space, driven by:

• A strong balance sheet that is in excellent condition at 36% debt-to-capital with no debt due before 2014
• 2011 cash requirements (capital expenditures (capex) and dividends) of approximately C$570 million, which is nearly matched with cash flow of about C$540 million (one of the better free cash flow situations of the E&Ps that I follow)
• Consequently, BTE will not have to cut capex or its C$0.22 per month dividend

As a result, I am confi dent that BTE will outperform its small-to-mid cap, oil-weighted E&P peers over the near term because the chief concerns of the marketplace are excessive leverage and funding gaps, which are not issues for Baytex.

I am also bullish on Baytex long-term, as it screens well on my other two fundamental criteria (reserves and production growth), in addition to a strong balance sheet and P&L.

Baytex has excellent breadth and depth in its reserve/resource portfolio. The company’s proved plus probable (2P) reserve life is approximately 13 years, and operations are located in three distinct, locations: Seal in central Alberta, Lloydminster in western Saskatchewan and the Bakken in northern North Dakota.

The breadth/diversity of locations reduces resource risk while keeping the company’s G&A costs in check. Baytex’s FY 2011 G&A expense is estimated at under C$2.30 per barrel of oil equivalent (boe).

Total boe production growth target is 8% per annum for the next five years, with oil production slightly outpacing that number. The lion’s share of that growth will come from cold fl ow and thermal oil production at Seal.

Production from Lloydminster is set to grow only 1%–2% per year — but it generates significant free cash flow; for 2011, EBITDA from Lloydminster will be approximately C$250 million with only C$90 million of capital expenditures.  

Baytex’s 132,000 net acres in the Bakken/Three Forks region only contributes approximately 3% of company-wide production currently, yet there is significant room to run with 100–300 potential net locations.

This asset has signifi cant upside production potential, and is also attractive in the M&A arena.

Baytex has a deep bench of technical officers on its management team. Four of the top officers have been either CEOs or COOs at other energy companies; this increases our confidence in the company’s ability to execute on its growth plan.

Baytex compares very favorable to industry production growth of +5.4% in the 4Q11. For 4Q11, I am modeling +22.6% year-over-year production growth at Baytex.

Growing production will help margins hold up in the face of volatile commodity prices and sticky fi eld costs. This is one of the better earnings set-ups going into the quarter that I have seen.

Learn more about this financial newsletter at Cabot Global Energy Investor.