The last few months have been very rough for Gran Tierra Energy (GTE) and their shareholders, who have seen their share price plunge around 75%. Given the extent of this downturn, it obviously causes many investors to question whether they have adequate financial strength to survive. Whilst their liquidity may seem decent on the surface, unfortunately this is not the case once digging deeper into their situation.
Cash Flows & Debt
Thankfully the graphs largely speak for themselves, with the first three graphs included below summarizing their cash flows and debt from the last quarter and previous seven years.
Image Source: Author.
Even before this latest oil price crash, they only ever produced free cash flow during one year within the last seven years. Given that there were several years of supportive operating conditions, such as 2014 and 2017-2019, this paints a poor picture for their long-term fiscal sustainability, especially since they were founded seventeen years ago and thus are not a brand new company. Since the beginning of 2013 their free cash flow has totaled negative $696m and if they ever hope to actually meet their future debt obligations and reward their long-suffering shareholders this trend will need to change rapidly.
When looking at the first quarter of 2020 it should be no surprise that this latest oil price crash has wreaked havoc on their operating cash flow, with it decreasing 88.40% year on year and 70.81% year on year if working capital movements are removed. To minimize their negative free cash flow, the company has elected to defer the majority of capital expenditures for the remainder of 2020, by stacking all drilling and workover rigs and suspending development activities.
Whilst this action helps in the short-term, given the capital intensity of their industry and field decline, it will clearly come at a medium to long-term cost. Due to the high volatility of oil prices and the large uncertainties surrounding the timing and extent of any recovery, it remains impossible to accurately predict their free cash flow going forward. Nonetheless, since oil prices have thus far averaged worse in the second quarter of 2020 than the first quarter, it seems highly probable that their negative free cash flow has continued and based on their historical performance, is likely to continue even if conditions modestly recover as capital expenditure is then reinstated. At the end of the day, their entire industry is facing a similar problem at the moment and thus their ability to outlast this downturn will depend upon their financial strength.
Image Source: Author.
Since their free cash flow has rarely ever been positive it was not surprising to see their net debt continuously increasing as well. When combined with acquisitions it has fallen from a highly desirable net cash position of $429m at the end of 2013 to a net debt position of $747m at the end of the first quarter of 2020. Ultimately whether this is a cause for concern will depend upon their broader financial position, however, their cash balance depleting is certainly not a positive sign for their liquidity.
Since their free cash flow will continue to suffer during this downturn, their overall financial position will be instrumental in determining their ability to survive. The two graphs included below summarizes their financial position from the last quarter and previous three to seven years.
Image Source: Author.
Once reviewing these financial metrics it becomes easily apparent that their leverage has been steadily increasing throughout the last three years. Whilst they did not enter this downturn as over-leveraged as some of their peers, it was still moderately high at the end of 2019, as evidenced by their gearing ratio of 40.13% and interest coverage of only 2.49. Naturally this situation has continued to deteriorate during the first quarter of 2020 and considering their poor history of negative free cash flow and the impacts from curtailing almost all capital expenditure, their leverage may continue deteriorating even once operating conditions recover. This paints a poor picture for their ability to survive this downturn, unless there is a very large and sustained rally in oil prices very soon, which seems alike to winning the lottery.
Image Source: Author.
Whilst their liquidity may technically look decent on the surface with current and cash ratios of 1.25 and 0.27 respectively, this is masking other concerns. Their cash balance of $39m only equals their negative free cash flow during the first quarter of 2020. Given their operating conditions have worsened during the second quarter of 2020, it stands to reason that most of, if not all of this cash will be depleted quite soon.
Once their cash balance approaches zero, they will be even more reliant on their credit facility, which is not an ideal situation even in the best of times, let alone for a small oil company during a severe downturn. Out of the original $300m borrowing base, they only have $96m left undrawn and this assumes that their lenders do not see fit to reduce their borrowing base during the May determination. Whilst the additional $96m is better than nothing, they cannot practically use all of these funds due to working capital requirements and thus at best this may only effectively buy them another quarter of two before facing an acute liquidity crisis.
Although they may be able to access additional borrowings, this would be very risky to count upon eventuating. Even during more accommodative times, small oil and gas companies with scant history of producing free cash flow are certainly not the most desirable companies for loans, especially ones that are already moderately highly leveraged.
Although they may find a way to survive this downturn, the odds appear stacked against them and thus they are an investment only suited to an investor with the highest level of risk tolerance. Even if they survive, they are hardly a desirable investment from a fundamental viewpoint that still faces long-term issues as the world moves away from fossil fuels. Given this it should come as little surprise that I believe a bearish rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Gran Tierra Energy’s SEC filings, all calculated figures were performed by the author.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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