Groundstar Resources Offers Compelling Risk/Reward in Next 6 Months
Lower-Risk Heavy Oil Production, Pristine Balance Sheet & Growing Cash Flow to Fuel Bigger Opportunities
Groundstar Resources (TSXV: GSA) is a heavy oil developer & light oil explorer in Saskatchewan and Alberta, Canada. Groundstar is cash flow positive today, has zero debt drawn on a C$10 million credit facility and is sitting on C$1.9 million of cash. The company has 2 foreign assets that could be advanced or monetized, (one of which is a free carried interest with blue-sky potential) and millions of dollars in tax pools. It has a tight capital structure with 27 million shares outstanding trading at C$0.155, for a market cap of C$4.2 million and an Enterprise Value, “EV” (Market cap + Debt – Cash) of about C$2.3 million. Groundstar has a 42.5% working interest in 2 successful heavy oil wells at Neilburg with a third well being drilled this week and and another several weeks after that.
Groundstar is flying under the radar with a new management team. The company is now focused on near-term, lower-risk opportunities to grow production and demonstrate repeatable drilling success in both heavy and light oil fields in western Canada and targeting a single international asset that has the possibility of being very significant for the company.
Based on the results of the two existing wells and offset wells operated by Crew Energy, it appears reasonable that the 4 Neilburg wells combined could be producing 200-250 bpd, (net to Groundstar) by September/October. I believe that cash flow to Groundstar could be approximately C$200k per month from its interest in these 4 heavy oil wells alone. [Note: all of the production and cash flow estimates herein are entirely my own based on publicly available information from western Canadian peers.] Twelve months of cash flow at C$200k per month would be equal the entire EV of the company.
New heavy oil opportunities are currently being evaluated in areas outside, but close to Neilburg. These locations are thought to have similar economics to the Neilburg wells. I believe that working interests in future wells outside Neilburg could be 50% or higher. Cash and cash flow are king, Groundstar has both, it can take down larger working interests in these lower-risk heavy oil wells going forward.
Near-Term Catalyst– Expansion Into a Highly Prospective Light Oil Play
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Building from a solid base of steady cash flow and a pristine balance sheet, Groundstar plans to drill for light oil at a highly prospective Morrinville reef play in central Alberta. At least 2 and up to 4 wells are being contemplated. The company will retain a 75% working interest in the first well and 75%-100% working interests in subsequent wells. Groundstar is budgeting 100 bpd (75 bpd net to Groundstar) on the first well. At that rate on a high-netback, light-oil well, the economics would be solid. However, based on recently processed 3-D seismic and nearby producing wells, Groundstar believes there’s a decent chance that the Morrinville wells could produce at considerably above 100 bpd. Why might this be? Offset wells have been mapped and carefully studied. Two successful representative wells on the fringe of the reef have been solid producers from 1.5 and 3.0 meters, respectively, of net pay. By contrast, Groundstar’s first two wells are expected to drill into the heart of the reef at 7-10 and 5-7 meters, respectively, of net pay.
Assuming a conservative 100 bpd on 2 wells and a 75% working interest on both, that would be 150 bpd net to Groundstar. That’s 150 bpd of high quality, light oil, which I think would be a good outcome. However, if the company is fortunate enough to drill 4 wells that ultimately produce at 200 bpd, that would be 600 bpd net to Groundstar based on a conservative 75% working interest on all 4 wells. How much is 600 bpd of light oil worth? On an EV per barrel metric, light oil companies are frequently valued by the market at C$50k-C$100k per daily flowing barrel. Assuming a conservative C$20k per flowing barrel x 600 bpd, that alone could be C$12 million, roughly 4x the current EV of the company.
The Third Leg of the Stool- Acquisitions….
I mentioned that cash and cash flow are king. Although a small company, cash and cash flow relative to the current EV is poised to continue growing, especially if multiple Morinville light oil wells come to fruition. All of this could happen the next few quarters, not years. A key strategic advantage that Groundstar has is its balance sheet. With a $10 million undrawn facility and a growing pile of cash, it can cherry pick non-core and/or distressed assets or farm-in / JV with peers. The company’s steady production growth this year has set it up to be buyer of distressed assets in western Canada, of which there are a surprising number. In looking at about a dozen peers, some have excessive debt levels. For example, 2 have net debt levels 5x-7x the size of their respective market caps. Groundstar is in a prime position to make deals.
Groundstar is in talks with multiple parties regarding a range of potential acquisitions, farm-ins and JVs. The company is taking a methodical approach in evaluating these opportunities and is committed to only striking attractive deals. Unlike many cash burning juniors, management is in no rush. Only prudently funded deals are being considered. The company has no interest in betting the farm on higher risk plays, stretching its balance sheet or heavily diluting shareholders.
With Groundstar, investors have the stability of production and cash flow from relatively low-risk heavy oil wells and the expansion into higher-value light oil production with a possibility that the light oil program at Morrinville could be highly significant. All of this should play within months, not years. None of the above mentioned activities is especially high risk, none are in dangerous foreign jurisdictions. On top of this is the company’s one international gambit that could pay off tremendously, but it’s too early in the process to make any assumptions about the ultimate outcome there. Groundstar offers compelling risk/reward at the current EV of C$2.4 million. If the company can execute on the above mentioned initiatives, the share price should move a lot higher by year-end.
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