Hemisphere Energy offers a 6% dividend yield and a 30% payout ratio (TSXV:HME:CA)
Hemisphere Energy (OTCQX: HMENF) (TSXV:HME:CA) is a junior Canadian oil producer with a total oil equivalent production rate of just under 3,000 boe/day in the second quarter. The company seems more interested in generating free cash rather than aggressively pursuing production growth. The company now pays a dividend and buys back its own shares under an ongoing buyback program.
As the company publishes its financial results in Canadian dollars and its Canadian listing is more liquid with a average daily volume of about 150,000 stocks, I will refer to the Canadian list throughout this article. The stock symbol in Canada for Hemisphere is HME. There are currently 102.5 million shares outstanding, giving a market capitalization of approximately C$167 million at the current share price.
High Oil Price Means Strong Cash Flow
During the second quarter of the current fiscal year, Hemisphere’s average production rate was just under 2,900 barrels of oil equivalent per day. This allowed Hemisphere to report total revenue of just under C$31 million and after deducting royalties payable on production and after deducting coverage losses of C$2.55 million, Hemisphere reported a net revenues of CA$19.5 million.
As you can see from the image above, the production costs of the business are quite low and about a third of the total operating costs are made up of depletion and depreciation expenses. This means that despite the high cost of royalties and despite the hedging losses, the company was still able to report an operating profit of C$13.7 million and a net profit of C$4.1 million for EPS. of C$0.04 per share. This includes a finance charge of C$4.8M which seems quite high, but mainly consists of the change in the value of the warrant liability related to the 13.75M warrants issued to a lender in 2017 The finance charge was caused by the warrant holder exercising their warrants on a cashless basis, resulting in a non-monetary loss related to the warrants.
This is important because these financial expenses are clearly non-cash expenses. And as you can see below, reported operating cash flow before changes in working capital position was approximately C$14 million after adding finance charges and deferred taxes (Hémisphere will have to probably start paying taxes again in 2023 as the deficit on the balance sheet decreases.
But for the second quarter of this year, Hemisphere spent about C$6.1 million on capital expenditures and lease payments. As you notice, the level of investment was a significant increase from the C$1.8M in the first quarter, and the result of this increase in spending will become clear in the current quarter, as July production has already increased by about 10% compared to the average production rate in Q2.
Free cash flow in the second quarter was approximately C$7.9 million and if you deducted deferred taxes, the free cash flow result would have been only C$4.1 million. Keep in mind that the full-year capital expenditure forecast is only C$16 million, which equates to C$4 million per quarter, which would have brought the free cash flow result below assets at more than C$0.06/share.
Keep in mind there are still hedges in place as you can see below but a bunch of sold call options expire at the end of this month while a sell spread strategy will be deployed for the last four months of the year.
What is Hemisphere’s capital allocation plan?
Hemisphere seems determined to involve shareholders in the cash flow generated by the company. Rather than spending every dollar to expand the production base, the company recently implemented a dividend policy. The first quarterly dividend was paid during the second quarter and Hemisphere elected to keep the dividend unchanged at C$0.025/share for the current quarter. This means that the current dividend yield exceeds 6%.
The dividend policy is quite simple: Hemisphere will pay out 30% of the annual flow of available funds. And looking at the chart below, Hemisphere will generate C$33M of free cash flow using an oil price of US$85/barrel, which would translate to about C$0.10/share in dividends (this which is the rate at which Hemisphere is currently producing. But we also know that capex includes growth capex and we also know that the exit rate should be 3,300 barrels of oil equivalent per dayan increase of 10% compared to the current rate of production.
This means that at US$85 WTI we can probably expect free cash flow to increase further to CA$35-38m, although capital expenditure needs will likely also increase due to the impact of the inflation on drilling and completion activities.
In addition to the dividend, Hemisphere also has a stock buyback program. During the second quarter, it spent approximately C$1 million to repurchase just over 650,000 of its own shares. This share repurchase authorization was extended in July and the company is authorized to repurchase up to 8.9 million shares for cancellation by July 13 next year (at which time the redemption authorization could easily be extended again).
I now have a long position in Hemisphere Energy and will look to increase this position on weak days. Hemisphere’s value is supported by a reserves value of C$1.70 per share using $70 of oil for proven reserves developed into production. Looking at the 2P reserves, the NAV/share increases to over C$3 per share.
I like the split between buying back shares and paying a relatively attractive dividend. And keep in mind that the current dividend yield of 6% is based on a payout ratio of just 30%.