Production a bit light, but recent drilling will help

Financial results reflect recent investments

Hemisphere completed year full of growth

Initiating with an Outperform Rating and $2.25 Price Target

Michael Heim

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Energy

Oil & Gas

Hemisphere Energy Corp

<p><strong>Accelerated drilling is beginning to lead to strong production growth.</strong> Production rose 20% year over year and 7% quarter over quarter. Growth came from two production wells that came on line early in the quarter. After paring back drilling in 2020 when oil prices were low, the company has accelerated its drilling efforts. Capital expenditures, which were typically around C$10 million dropped below C$2 million in 2020, rose to C$19 million in 2022, and look to remain in the C$15-C$20 million range for the next few years. This has led to a doubling of production since 2020. With an active drilling program planned for the fall, look for production to show similar growth at the end of 2023 and the first quarter of 2024. Our models show production crossing 4,000 boe/d by the end of 2023.</p>
<table border="1" style="border-collapse: collapse;width: 478px;height: 77px">
<tbody>
<tr style="height: 18px">
<td style="width: 194px;height: 18px">
         </td>
<td style="width: 69px;height: 18px">2023-1Q</td>
<td style="width: 63px;height: 18px">2022-1Q</td>
<td style="width: 68px;height: 18px">2022-4Q</td>
<td style="width: 84px;height: 18px">Noble Est.</td>
</tr>
<tr style="height: 19px">
<td style="width: 194px;height: 19px">Gas production (mmcf/d)</td>
<td style="width: 69px;height: 19px">169</td>
<td style="width: 63px;height: 19px">141</td>
<td style="width: 68px;height: 19px">184</td>
<td style="width: 84px;height: 19px">190</td>
</tr>
<tr style="height: 22px">
<td style="width: 194px;height: 22px">Oil production (bbls./d)</td>
<td style="width: 69px;height: 22px">3,143</td>
<td style="width: 63px;height: 22px">2,624</td>
<td style="width: 68px;height: 22px">2,943</td>
<td style="width: 84px;height: 22px">2,899</td>
</tr>
<tr style="height: 18px">
<td style="width: 194px;height: 18px">Total production (boe/d)</td>
<td style="width: 69px;height: 18px">3,171</td>
<td style="width: 63px;height: 18px">2,648</td>
<td style="width: 68px;height: 18px">2,974</td>
<td style="width: 84px;height: 18px">2,930</td>
</tr>
</tbody>
</table>
<p><strong>But basin differential issues are leading to lower-than-expected pricing.</strong> Realized oil prices fell to C$65.51/bbl. from C$96.53/bbl. That was not a surprise. West Texas Intermediate oil prices fell 19% over the same time period. What is more concerning is that the realized oil price Hemisphere Energy (HME) received fell 32%. The chart below shows the differential between HME&#8217;s realized price and WTI prices as expressed in C$. As the chart shows, the differential has increased in recent quarters with the last three quarters being significantly larger both in absolute terms and on a percentage basis. We would note that other western Canadian oil producers have reported a similar widening of basin differential. There are many reasons why the basin differential might have expanded. Increased production in the area sometimes gets ahead of infrastructure developments that are designed to take the oil. Note that the Hemisphere&#8217;s transportation costs per boe have risen to $3.21 in the quarter as compared to $2.27 in the March quarter last year perhaps giving credence to infrastructure issues. Another explanation for the widening differential may be simply based in supply and demand perhaps due to weather conditions or economic development differences between the locations. Whatever the reason, it is worth tracking and making adjustments in our models to reflect the widening differential.<br />
   </p>
<table border="1" style="border-collapse: collapse;width: 741px;height: 72px">
<tbody>
<tr style="height: 18px">
<td style="width: 178px;height: 18px">
         </td>
<td style="width: 62px">2021-1Q</td>
<td style="width: 62px;height: 18px">2021-2Q</td>
<td style="width: 66px;height: 18px"> 2021-3Q</td>
<td style="width: 64px;height: 18px"> 2021-4Q</td>
<td style="width: 64px;height: 18px"> 2022-1Q</td>
<td style="width: 62px;height: 18px"> 2022-2Q</td>
<td style="width: 61px;height: 18px"> 2022-3Q</td>
<td style="width: 59px;height: 18px"> 2022-4Q</td>
<td style="width: 63px;height: 18px"> 2023-1Q</td>
</tr>
<tr style="height: 18px">
<td style="width: 178px;height: 18px"> WTI Oil Price US$</td>
<td style="width: 62px">57.79</td>
<td style="width: 62px;height: 18px"> 66.03</td>
<td style="width: 66px;height: 18px"> 70.56</td>
<td style="width: 64px;height: 18px"> 77.19</td>
<td style="width: 64px;height: 18px"> 94.29</td>
<td style="width: 62px;height: 18px"> 108.72</td>
<td style="width: 61px;height: 18px"> 91.56</td>
<td style="width: 59px;height: 18px"> 82.65</td>
<td style="width: 63px;height: 18px"> 76.08</td>
</tr>
<tr style="height: 18px">
<td style="width: 178px;height: 18px"> WTI Oil Price C$</td>
<td style="width: 62px">73.24</td>
<td style="width: 62px;height: 18px"> 82.54</td>
<td style="width: 66px;height: 18px"> 88.87</td>
<td style="width: 64px;height: 18px"> 97.30</td>
<td style="width: 64px;height: 18px"> 119.43</td>
<td style="width: 62px;height: 18px"> 135.90</td>
<td style="width: 61px;height: 18px"> 119.56</td>
<td style="width: 59px;height: 18px"> 110.20</td>
<td style="width: 63px;height: 18px"> 101.44</td>
</tr>
<tr style="height: 18px">
<td style="width: 178px;height: 18px"> HME Rlzd. Oil Price C$</td>
<td style="width: 62px">53.34</td>
<td style="width: 62px;height: 18px"> 62.78</td>
<td style="width: 66px;height: 18px"> 68.39</td>
<td style="width: 64px;height: 18px"> 74.43</td>
<td style="width: 64px;height: 18px"> 96.53</td>
<td style="width: 62px;height: 18px"> 116.65</td>
<td style="width: 61px;height: 18px"> 90.39</td>
<td style="width: 59px;height: 18px"> 73.52</td>
<td style="width: 63px;height: 18px"> 65.51</td>
</tr>
<tr>
<td style="width: 178px">Differential C$</td>
<td style="width: 62px">(19.90)</td>
<td style="width: 62px">(19.76)</td>
<td style="width: 66px">(20.48)</td>
<td style="width: 64px">(22.87)</td>
<td style="width: 64px">(22.90)</td>
<td style="width: 62px">(19.25)</td>
<td style="width: 61px">(29.17)</td>
<td style="width: 59px">(36.68)</td>
<td style="width: 63px">(35.93)</td>
</tr>
<tr>
<td style="width: 178px">Differential %</td>
<td style="width: 62px">27</td>
<td style="width: 62px">24</td>
<td style="width: 66px">23</td>
<td style="width: 64px">24</td>
<td style="width: 64px">19</td>
<td style="width: 62px">14</td>
<td style="width: 61px">24</td>
<td style="width: 59px">33</td>
<td style="width: 63px">35</td>
</tr>
</tbody>
</table>
<p> <strong>Even with the drop in realized oil prices, netbacks and fund flow are attractive.</strong> The days of US$120 oil prices were not going to last forever. And with the drop in oil prices, it was inevitable that operating field netbacks would decline. That said, we would point out that energy companies like Hemisphere are generating significant cash flow at current energy prices. Hemisphere is generating close to C$40 million in annual adjusted fund flow which is well above projected capital expenditures of C$15 million and the current indicated annual dividend payment rate of roughly C$10 million. The board of directors recently announced a dividend of $0.025 per share, equal to the last dividend payment. Unless there is a sharp drop in energy prices, we believe the board could consider a modest boost to the dividend this summer.<br />
   </p>
<table border="1" style="border-collapse: collapse;width: 529px;height: 127px">
<tbody>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">
         </td>
<td style="width: 66px;height: 18px">2023-1Q</td>
<td style="width: 68px;height: 18px">2022-1Q</td>
<td style="width: 72px;height: 18px">2022-4Q</td>
<td style="width: 87px;height: 18px">Noble Est.</td>
</tr>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">Realized Petroleum Price C$/boe</td>
<td style="width: 66px;height: 18px">65.51</td>
<td style="width: 68px;height: 18px">95.92</td>
<td style="width: 72px;height: 18px">73.08</td>
<td style="width: 87px;height: 18px">80.68</td>
</tr>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">Royalty Costs C$/boe</td>
<td style="width: 66px;height: 18px">(11.47)</td>
<td style="width: 68px;height: 18px">(19.80)</td>
<td style="width: 72px;height: 18px">(16.49)</td>
<td style="width: 87px;height: 18px">(16.49)</td>
</tr>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">Operating Costs C$/boe</td>
<td style="width: 66px;height: 18px">(11.08)</td>
<td style="width: 68px;height: 18px">(8.95)</td>
<td style="width: 72px;height: 18px">(13.14)</td>
<td style="width: 87px;height: 18px">(13.00)</td>
</tr>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">Transportation Costs C$/boe</td>
<td style="width: 66px;height: 18px">(3.21)</td>
<td style="width: 68px;height: 18px">(2.27)</td>
<td style="width: 72px;height: 18px">(2.64)</td>
<td style="width: 87px;height: 18px">(2.50)</td>
</tr>
<tr style="height: 18px">
<td style="width: 236px;height: 18px">Operating Field Netback C$/boe</td>
<td style="width: 66px;height: 18px">39.75</td>
<td style="width: 68px;height: 18px">64.89</td>
<td style="width: 72px;height: 18px">40.81</td>
<td style="width: 87px;height: 18px">48.69</td>
</tr>
<tr style="height: 19px">
<td style="width: 236px;height: 19px">Adjusted Fund Flow C$1000</td>
<td style="width: 66px;height: 19px">8,280</td>
<td style="width: 68px;height: 19px">11,039</td>
<td style="width: 72px;height: 19px">11,012</td>
<td style="width: 87px;height: 19px">9,593</td>
</tr>
</tbody>
</table>
<p>
   </p>
<p><strong>With results being reported near expectations, we are comfortable reiterating our Outperform rating and our $2.25 price target.</strong> Earnings for the quarter were C$6.0m ($0.06 per share) up from earning of $4.6m ($0.05 per share) for the same period last year. Results were slightly below our estimate of C$7.5m ($0.07 per share) due mainly to the widening basin differential discussed above. However, we believe the long-term investment premise remains intact. As a reminder to investors, our valuation estimates assume a long-term WTI oil price assumption of $60 per barrel. And, even as oil prices have weakened over the last twelve months, they remain above the level assumed in our valuation. We believe management is doing a prudent job with its positive cash flow, first by increasing investments and reducing debt levels and then by initiating a dividend and a share repurchase program. We believe continued oil price strength will allow management to continue to expand dividend payments and share repurchases.</p>
<p>
   </p>
<p>
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Hemisphere Energy Corp (HMENF)

Financial results reflect recent investments

Fundamental Analysis:

Rating: Log in to view

Production a bit light, but recent drilling will help (HMENF)

Financial results reflect recent investments (HMENF)

Hemisphere completed year full of growth (HMENF)

Initiating with an Outperform Rating and $2.25 Price Target (HMENF)

Inbox Intel from Channelchek.