InPlay Oil Stock: More growth on the horizon (TSX:IPO:CA)

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(Note: This article originally appeared in the June 17, 2022 newsletter and has been updated as needed.)

Note: This is a company that reports in Canadian dollars unless otherwise specified.

InPlay Oil (OTCQX:IPOOF) (TSX:IPO:CA) is still another oil game that originally made public through a reverse merger with the former Anderson Energy (AXLFF). Despite the relatively small size of the company, I thought the backing of the entity performing the reverse merger was impressive enough to cover the stock. This company got one hell of a scare in fiscal 2020 when cash flow plummeted to previously unimaginable levels. But the quick-thinking management has embarked on enough accretive mergers to be able to pay off debt this fiscal year. After that, the business will grow and eventually sell at the right price.

History of InPlay Oil Growth and Profitability

History of InPlay Oil Growth and Profitability (InPlay Oil May 2022, Corporate Presentation)

Management has impressively increased cash flow through a combination of skillful acquisitions, aided by higher commodity prices. This caused the worrying leverage ratio to drop rapidly. Management intends to repay substantially all of the debt this fiscal year to permanently “put to bed” any market concerns about leverage.

The latest report for the second quarter demonstrated that management is focused on debt repayment indicating approximately C$25 million repaid compared to the prior year. The current environment has greatly reduced debt problems thanks to rather generous cash flows.

The combination of organic growth and acquisitions has led to impressive growth per share from a very small initial production base. This company, like many, went public with high hopes for profitable growth to meet the challenges of fiscal 2020. Management was nimble enough to respond quickly to Mr. Market’s demands.

This company is not likely to be a revenue vehicle due to the very small size of the business. Instead, the first priority will be to ramp up production to an appropriate level so that the company weathers the next downturn with much better debt and cash flow ratios than was the case during the 2020 financial year.

Most know that 2020 is unlikely to repeat itself in the near future. But there has now been an industry downturn in 2015, 2008 and of course 2019 which has rapidly worsened beyond anything anyone could have predicted. This caused many of them to operate much more conservatively than was the case in the past.

Many companies that acquire do so either by using stock or by selling stock as part of the process of keeping debt levels low. The market no longer accepts a “leveraged” acquisition followed by asset sales due to the fear that accompanied the challenges of fiscal 2020. As a result, the industry will show a good number of very strong balance sheets in the foreseeable future. The money that enabled unhealthy production and leverage is now gone. Money that knows this industry is not going to suddenly “go wild” and do things that lenders know won’t be profitable.

InPlay Oil Second Quarter 2022 Operating and Financial Results

InPlay Oil Second Quarter 2022 Operating and Financial Results (InPlay Oil Earnings Press Release Second Quarter 2022.)

InPlay Oil has long had some of the most impressive netbacks in the industry. The production amounts combine with this net income to produce one of the most profitable small businesses in the industry.

It should be noted that prior years’ earnings include the reversal of impairment charges that are permitted under Canadian accounting rules, but now permitted under US GAAP.

Rapid growth can be a risk in itself as logistical challenges can lead to quality and production issues. This has not happened here so far. Some of this can be attributed to the experience of management and funders of construction and sales companies in the past. The saying “practice makes perfect” applies particularly to this business.

There is every chance that the company can grow rapidly in the future without running into many growth “blocks” that cripple other directions.

The allure of small businesses is often that growth rate per share. Here, the projected cash flow is about a third of the stock price. Considering the likelihood of more transactions in the future and decent organic growth in the current environment, this price is pretty cheap.

InPlay Oil Alberta operating results

InPlay Oil Alberta Operating Results (InPlay Oil May 2022, Corporate Presentation)

InPlay Oil is able to leverage smaller stakes than many of its larger peers. The business often grows by acquiring “bolt-on” acquisitions from these small holdings. This type of acquisition is less risky because the management knows the surrounding land well.

The province of Alberta is very supportive of the oil and gas industry. Thus, Cardium is a good place to conduct operations.

Wells are relatively cheap wells with lower reserves per well. But this feature makes it much easier for the company to adapt production to industry conditions. The return on investment for these wells is very short under current industry conditions.

Cardium itself has long been a productive area like Austin Chalk is in Texas. The game, like the Austin Chalk, has been revolutionized by the advancement of technology. This allowed the two pieces to make an unexpected comeback several years ago.

Cardium is a stacked game. Thus, there are several intervals that contain potentially commercial reserves that have not yet been explored. The result of continuous improvement in technology likely means that Cardium and associated intervals will be a major production pool for years to come.

The future

Management will focus on Cardium and Alberta over the next few years as the business grows.

InPlay Oil Cardium Profitability Features

Profitability characteristics of InPlay Oil Cardium (InPlay Oil May 2022, corporate presentation.)

Clearly, sinks are very profitable in the current industry price atmosphere. The only real goal is to maximize profitability by achieving a desirable amount of production. This objective is facilitated by operating in a basin with plenty of supporting infrastructure and transport capacity.

There is currently some cost inflation that the industry has to deal with. Whether management can compensate for this inflation through technological advancements or certain management actions is currently unknown, likely until the next presentation is released.

This small business is one of the few that can grow and reduce its debts. Many industry players are focused on repairing the balance sheet in the current fiscal year. The sink rate of wells promotes cash flow growth as it is much lower than many unconventional wells. Therefore, payment occurs at a considerably higher level of production than is the case for many companies operating in the United States.

Not only does payback occur at a relatively higher level of production (compared to initial rates), but it also occurs quickly enough to allow management to drill a second well with the same capital in the same fiscal year. . This accelerates the build up of cash flow, so the next downturn will occur with production significantly above break-even at lower levels.

Wells that have earned a return on investment will produce during an industry downturn as long as the sale price provides adequate cash flow above production costs. The reports can be very different as the costs are broken down into quarterly reports over the estimated life of the well. However, an environment like this allows the company to pay down its debt while preparing for the next economic downturn with many well costs repaid. There won’t be many costs to recoup during the downturn outside of current production costs. This would allow the management to simply cash the checks for the production sold while waiting for the next recovery.

This management will likely continue to build the business as long as the environment is favorable while looking to eventually sell the business at the right price. For long-term shareholders, this can be a very tempting proposition.

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