Topaz Energy combines midstream and royalty business models within the oil and gas industry. Operating in Canada and reporting in Canadian dollars, the company has begun to diversify away from Tourmaline (TOU) (OTCPK), though significant connections remain.
The royalty business focuses on natural gas production, with promising future liquid production from its acreage.
Dividend Policy
Topaz Energy’s quarterly dividend is set at C$0.32 per share. Although the dividend has grown rapidly, future growth is expected to slow as the company establishes a solid business base. The dividend, slightly more than half of the reported cash flow, allows for debt repayment and business expansion through reinvestment.
Earnings
In the current quarter, cash flow dipped below C$0.50 per share due to weaker natural gas prices, offset slightly by increased liquids production and stronger liquids prices. Like most royalty companies, Topaz does not control development rates in its lease areas, necessitating careful selection of royalty interests.
Despite a slight decline in production from the fourth quarter, the overall trend shows growth. This decline likely stems from natural gas producers timing production increases with the heating season for better pricing.
The company’s midstream exposure allows participation in projects, offering another growth avenue. However, as a smaller entity, growth may occur in significant lumps post-acquisitions, potentially posing valuation challenges due to market preference for steady, predictable growth.
Midstream Business
Canadian midstream operations tend to be more capital-intensive than in the United States, as smaller companies often own oil batteries and natural gas processing plants. Topaz provides capital for these plants, earning non-operating interests in return.
This arrangement ensures a steady income stream from infrastructure assets, counterbalancing the volatility of upstream royalty interests. Despite weak natural gas prices, these assets provide a stable income floor, making the company’s income less volatile than a typical royalty company but more variable than a typical midstream company.
Royalty production can grow without capital investment from Topaz, though the growth rate is not controlled by the company. Conversely, midstream income likely requires capital investment for material growth, given high usage rates of existing midstream interests.
The Clearwater Royalty assets represent the fastest-growing part of Topaz’s portfolio. This area is highly profitable, with industry activity levels above average. Although currently a small part of the business, rapid growth here could lead to significant future expansion. Importantly, Topaz participates in this growth without any capital investment.
Other Material Interests
Topaz also holds interests in the Deep Basin and Peace River areas, with Tourmaline’s natural gas interests currently dominating royalty income. Future changes could occur as more liquid-producing intervals come online. Management may periodically make accretive acquisitions to support overall growth.
Positioned for Growth
Topaz Energy is poised for high single-digit to low-teen growth rates overall. Acquisitions of additional interests may result in significant growth years amidst steady growth periods.
Although some may view this as a speculative investment due to its newness, the royalty business lacks typical upstream risks like dry wells. Royalty companies receive payments “off the top” with minimal deductions, ensuring large margins.
Enjoying Large Margins
The midstream business, being non-operated, also enjoys large margins. With relatively high yield dividends around 6%, the combined dividend yield and growth rate should attract investors. Potential investors, especially those outside Canada, should consult a tax expert to avoid surprises.
Interesting Investment Prospect
Topaz Energy represents interesting investment prospects for those willing to accept the risks associated with a new company and its rapid growth. Management still needs to demonstrate long-term asset performance. After five years, many new company issues typically diminish.
Despite lower risk compared to other parts of the oil and gas industry, there are inherent risks. Non-operated investments can misjudge future profitability, and the royalty business is subject to volatile commodity prices. Midstream interests often depend on the financial health of upstream companies. The loss of key personnel could also impact future prospects, though Tourmaline’s backing mitigates this risk.
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