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Bellatrix Exploration – A True Survivor

Bellatrix (BXE) just reported Q4 earnings along with year-end results. To say that the results were impressive would be an understatement.

I have written up BXE numerous times over the past year and alluded to how prolific the Spirit River formation is. The cost differential between the Spirit River and BXE’s other plays has such a big difference that simply shifting more of its production into Spirit River would drastically lower the overall cost profile of BXE.

Q4 results illustrated what a focused management team coupled with a prolific play could do to the overall cost profile of the company.

Investment Thesis Revisited

In my write up posted last year, I talked about how I believed BXE could become one of the lowest cost producers in Canada. I specifically illustrated the economics of drilling in the Spirit River vs. BXE’s other plays.

Bellatrix Exploration – A True Survivor Bellatrix (BXE) just reported Q4 earnings along with year-end results.

The premise of the original BXE investment thesis was simple. As the company continues to drill in the Spirit River, the natural cost shift from the higher cost production will gradually be overtaken by the low cost Spirit River play.

In Q3 2015, BXE started breaking down the mix of the production:

The breakdown is very meaningful because it tells us two things: 1. Shareholders can break down

The breakdown is very meaningful because it tells us two things:

  • 1. Shareholders can break down just how much of the cost proponent is attributed to non- Spirit River plays.

  • 2. It explains why the cost curve continues to decrease meaningfully.

BXE’s results were above and beyond my expectations as it demonstrates to me that the original thesis continues to be in tact and that a rebound in commodity prices would allow BXE to benefit from the structural efficiency gains the company has experienced over the last year.

In a recovering commodity price environment, BXE would be trading considerably higher than today’s $1.16 per share.

Reserve Analysis

Along with Q4 2015 earnings release, BXE also released its end of the year reserve report.

The breakdown is very meaningful because it tells us two things: 1. Shareholders can break down

Total reserves decreased from 250 MMboe to 223 MMboe. The bulk of the decrease was due to write offs associated with BXE’s Cardium and non-core assets. There aren’t too many plays

today that are economical at sub C$2 AECO gas and sub $40 WTI. Spirit River remains one of the top plays, but other assets BXE owned had to be written down.

On a PV-10 basis, BXE is worth C$4.27 per share. With the stock trading at C$1.52, the margin of safety is substantial, and I believe the PV-10 value will be written up as commodity prices continue to recover.

One interesting note is that despite historically low commodity prices, BXE still added reserves in the Spirit River of around 11 million boe/d net Grafton’s JV stake. This is a big positive and I expect BXE to continue to add to reserves.

Business Analysis Update

Costs this quarter were much lower than I expected. Here are a few notable highlights:

Operating costs/boe and net G&A costs/boe continues to trend down.

today that are economical at sub C$2 AECO gas and sub $40 WTI. Spirit River remains

In my model, which I will share below, opex/boe came in with my expectations that it should fall below C$7/boe. BXE is currently still guiding C$7.25/boe for 2017. I believe Ray Smith, CEO of BXE, and his team are being safe with the guidance and giving themselves ample room to outperformance on the cost front. I expect opex/boe to actually average C$6.75/boe in 2017. I don’t mind BXE continuing to make sell-side look bad, but when they realize that their cost estimates are too high, they will catch on.

G&A costs continue to trend down as Ray and the team continues to aggressively cut costs. This is showing up in Q4 as G&A decreased from C$1.38 to C$1.18 or a decrease of ~15%. Transportation expenses continue to trend down thanks to the Alder Flat gas plant that went online in July 2015.

This is what the CFO had to say about the structural cost compression when asked on the Q4 2015 conference call:

This is what the CFO had to say about the structural cost compression when asked on

Given his response, I believe they are simply being conservative. Why? Take a look at what they said in Q3 2015 when asked about Q4 guidance for operating cost versus what the actual was.

This is what the CFO had to say about the structural cost compression when asked on

For the full year 2015, BXE kept guidance at C$8 opex/boe, but the ACTUAL results came in at C$7.86 opex/boe.

Q4 2015 opex/boe is currently sitting at C$6.87/boe, and I expect that to be roughly the opex/boe figure for 2016 as the production mix continues to be more heavily weighted towards the Spirit River.

Transportation cost per boe also saw a dramatic move lower from C$1/boe to C$0.72/boe. This is what the CFO had to say about it on the Q4 2015 call:

Transportation cost per boe also saw a dramatic move lower from C$1/boe to C$0.72/boe. This is

Given that these are some structural changes; I believe the street didn’t expect this.

Implications for 2016

In the first three months of 2016, BXE continues to proactively hedge commodity prices with a 55% net hedge (after royalties) on its natural gas production @ C$3.03/mcf.

Looking at my model, BXE is pretty much free cash flow breakeven despite AECO gas being @ C$1.80/GJ for the rest of this year!

Transportation cost per boe also saw a dramatic move lower from C$1/boe to C$0.72/boe. This is

This is very meaningful as there were a lot of concerns whether BXE will survive the downturn or not, but the Q4 2015 report puts that concern away as the company’s superior cost structure will allow it to survive the storm.

The Potential for Propane Price

Aside from natural gas and oil, BXE produces ~3,000 boe/d of propane. In 2015, propane prices in Edmonton actually went negative for 3 months or so due to record inventory levels. Prices have recovered since to around C$9 boe. Inventory levels for propane has dropped drastically over the last few months thanks to record exports. Prices have yet to respond positively to the inventory drop, but my expectation is that propane prices will likely move to its historical average of being at 35% of Edmonton light oil prices. Given where oil prices are today, that could result in C$18/boe for propane. This increase of C$9/boe would increase BXE’s free cash flow by an additional C$10 million a year. This would allow it to continue to pay down debt and survive this downturn.

Concluding Thoughts

BXE’s Q4 results was the light at the end of the tunnel for shareholders. The company’s aggressive cost cutting strategy coupled with the prolific Spirit River well results will allow it to survive this downturn and thrive when commodity prices recover. At just 0.30x the current PV- 10 value, investors have substantial margin of safety to take on this bet. If WTI recovers to $60 and AECO gas to C3/mcf, BXE would be trading between $3 - $4 per share.