In November, I explained how I initiated a long position in InPlay Oil (OTCQX:IPOOF) by buying shares of Prairie Storm Resources, which was being acquired by InPlay Oil in a cash and stock transaction. . Unfortunately, the majority of the consideration was paid in cash, but that also meant that I was able to acquire InPlay Oil for an implied consideration of just C$0.98 per share. Today, just two months after this article was published, InPlay Oil is trading at around 3 Canadian dollars. Due to the very aggressive rise in the company’s stock price, I was considering selling my position and moving to greener pastures. I decided to run all the numbers again using the recently released advice update and decided there seemed to be more room to run.
InPlay Oil’s Canadian listing is the most liquid listing and I would recommend trading the company’s stock on the TSX where it trades with IPO as its ticker symbol. The current share price is just under C$3, giving the company a market capitalization of approximately C$255M. The average daily volume in Canada exceeds 270,000 shares.
Predictions for 2022 are all you need to know
On Jan. 12, InPlay Oil released its updated guidance for fiscal year 2022. The board approved a C$58 million investment program that is expected to see the company produce an average of 8,900 to 9,400 barrels of oil equivalent per day. According to IPO, this should translate to 55% to 63% production growth over 2021 production results, but I’m not sure that’s a fair comparison. After all, the acquisition of Prairie Storm was only finalized in the fourth quarter, so the starting point for production growth is well above the average production rate in 2021.
As such, I think it’s best to use the third quarter production rate as a starting point. InPlay’s own oil projects produced approximately 6,000 boe/day while Prairie Storm had attributable production of approximately 2,000 boe/day. This means that compared to the pro forma Q3 production rate, the production increase in 2022 will be around 15%.
It’s not bad, but it helps put things into perspective. The acquisition of Prairie Storm will help InPlay quickly reduce its average decline rate from 26% in 2021 to just 16% in 2022.
This is important because it also helps us determine how well InPlay is drilling. Assuming that approximately 1,500 barrels per day of oil production will need to be replaced to counter the average rate of decline, the total investment program of C$58 million should help cover the 1,500 boe/day to mitigate the decrease and finance the 900-1,400 boe/ increase in daily production. So, for C$58 million, InPlay will essentially be able to add 2,400 to 2,900 boe/day to the production profile. This translates to an average capital intensity of just under C$20,000 per barrel outstanding.
Of course, this interpretation is not 100% correct as there are several other factors at play here such as the timing of capital expenditures and it would also be interesting to know the exit rate that InPlay Oil is aiming for 2022. C$20,000 per barrel pouring is relatively high, so it looks like InPlay Oil is being a little conservative here, although the company warns of cost inflation in its forecast update.
So, to be on the safe side, I’ll use the aforementioned C$20,000 capital intensity per sinking barrel. If InPlay Oil ended the year with an exit rate of 9,400 boe/day, for example, the company would have to finance the activities to replace 1,500 boe/day in 2023, which would then represent a capex of 30 million Canadian dollars. This is the maintenance capex.
The 2022 forecast calls for an adjusted cash flow of C$111-117 million using US$72.50 of WTI and an AECO gas price of C$3.30. This is an important part of my reason for maintaining a position in InPlay Oil. Not only does this mean that the business will generate over C$50 million in free cash flow even after factoring in growth investments, it also means that at $72.50 oil the business will generate likely C$80 million to maintain its free cash flow in 2023, and likely a bit more as net debt will fall off a cliff, which should lead to a substantial drop in interest expense, which will further boost the adjusted cash flow.
At $72.50 oil, InPlay Oil could convert its net debt to net cash position by the end of the first quarter of 2023 (and even sooner, as every day the price of oil rises above $72.50, the cash flow will exceed expectations).
I’m also very happy that InPlay Oil provided the sensitivity analysis in the chart. This allows us to test cash flows using a worst-case scenario. If the price of oil drops to US$57.5 WTI and using an AECO gas price of CA$2.30, the AFFO will drop by about CA$35M (and probably a bit less than that, as the royalty bill will also be reduced). This means that using the above figures, the AFFO will still be around C$75 million, which translates to a free cash flow result of C$40-45 million. With less than 90 million shares outstanding, that means InPlay Oil will likely still generate a free cash flow result of C$0.50/share.
And that’s also a big reason why I plan to hold a position in InPlay Oil for the time being. Even at $57.50 WTI, InPlay is currently trading at just 6 times sustaining free cash flow (defined as AFFO minus sustaining investments). Cash flow could receive an additional boost by quickly paying down net debt. InPlay Oil is currently paying approximately C$5 million per year in interest costs and debt repayment could further increase the AFFO by 5%.