Canacol Energy Ltd (TSX: CNE) is a natural gas and oil exploration and production company. It operates primarily in the Lower & Middle Magdalena Basins of Colombia.

Key Highlights 

• Lucrative Dividend Yield: The Company has an excellent track record of dividend distribution and has increased its distribution over the years, reflecting resilience and healthy cash flow generation. Recently, the company paid a dividend of CAD 0.052 per share. At the last closing price of CAD 3.25, the stock offers a dividend yield of 6.40%, which translates into an essential factor for regular income-seeking investors with a long-term horizon.

• Improving Dynamics Despite Challenging Macros: Even though the industry's proven reserves are declining, the company has claimed successful exploration and drilling activities in recent years, with a 40% CAGR increase in gas sales over the previous seven years. As a result, the company has emerged as one of Colombia's most prominent players. The sector's overall gas supply has been sluggish in recent years and is expected to remain so in the future. However, due to a high reserve base, CNE supply is likely to stay elevated in the coming days.

• Increase in Demand for Spot Market Volumes: In Q3FY21, the realized contractual natural gas and LNG sales volumes increased 17% to 190.6 MMscfpd, compared to 163.0 MMscfpd for the same period in 2020. The increase witnessed by the company was mainly due to improved firm contract and spot market sales as a result of the COVID-19 pandemic restrictions being gradually lifted during the three months ended September 30, 2021.

• Industry Beating Margins: The Company's resilient business helped them leap the industry median margins on many fronts in Q3FY21, which is a key positive. The chart below gives a glimpse of this.

Financial Overview of Q3FY21 (in thousands of United States dollars)

Source: Company 

• In Q3FY21, the company reported total revenue of USD 81.9 million against USD 64.5 million in the previous corresponding period. The revenue increased primarily due to the higher sales volume of natural gas and liquefied natural gas.
• Total operating expenses in the reported period increased to USD 48.8 million against USD 38.8 million in pcp. Higher transportation expenses, increased depreciation costs, along with newly recorded exploration expenses and charges relating to natural gas trading purchases elevated total operating expenses.
• Income before tax in Q3FY21 stood at USD 24.8 million against USD 17.5 million in pcp, resulting from higher revenue generation.
• Due to the above-stated reasons, the net income in Q3FY21 increased to USD 8.8 million compared to USD 2.6 million in pcp, which was partially offset by higher income tax.
  

Risks Associated with Investment

The company's operations are correlated with the prices of oil & gas. Hence, volatility in the commodity prices would affect the company's overall realization and cash flow. 

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Stock Recommendation 

The company is well-positioned to produce consistent cash flows. Furthermore, the firm does not have any significant debt obligations until FY24, reducing the company's immediate repayment load. In addition, CNE is the leading supplier to the Caribbean Coast and has a competitive cost structure, which helps its profitability and margins. It is also in the process of drilling more wells which would open fresh avenues for cash flows. Also, the company is delivering a healthy dividend yield, which is another positive aspect for long term value investors. Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Speculative Buy" rating at the closing price of CAD 3.25 as on November 19, 2021. We have considered Nuvista Energy Ltd, Cardinal Energy Ltd, Tamarack Valley Energy Ltd, etc., as the peer group for the comparison.

1Year Price Chart (as on November 19, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

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