Although the recent oil price rally boosted TSX energy stocks, they are still trading much lower than their peaks. Baytex Energy (TSX: BTE) stock is an apt example. It has soared approximately 23% since last month but is still trading 50% lower than its 52-week high last November.
What’s so special about Baytex Energy?
Market participants expected Baytex to expand its footprint in Canada’s one of the most prolific oil plays: Clearwater. However, the company announced its acquisition of Ranger Oil, a surprise expansion in the U.S. Eagle Ford Basin.
The US$2.5 billion deal opens up a lot of growth opportunities for Baytex, though. The production is now expected to reach 155,000 barrels of oil equivalent per day from 88,000 barrels previously. It significantly increases the production of light oil, which trades at a premium. Another benefit of expanding in the U.S. Eagle Ford is its accessibility to the U.S. Gulf Coast. The premium pricing and lower transportation costs will likely help boost operating netback.
Effectively, this lowers Baytex’s exposure to the domestic benchmark Western Canadian Select on a total company-wide production level. Western Canadian Select trades at a significant discount to West Texas Intermediate, and the differential has widened since last year.
The company highlighted that with Ranger, its cumulative free cash flows will be around $3.6 billion through 2026, almost double compared to the standalone Baytex.
Debt reduction and shareholder returns
We have seen excess cash flows in the energy sector since the pandemic. Along with a focus on buybacks and dividends, merger and acquisition activities seem to be heating up in the sector. With companies sitting on surplus cash amid the strongest balance sheet positions ever, this could just be the start.
Thanks to its rapid free cash flow growth, Baytex Energy has repaid around $800 million of debt in the last two years. While the recent acquisition will increase the leverage ratios, it is still well below its long-term average. However, debt reduction remains the top priority for the management like its peers.
The company intends to allocate 75% of its free cash flows to shareholder returns when the total debt reaches to $1.5 billion. This will likely facilitate the reinstatement of dividends, probably in the fourth quarter (Q4) of 2023, which it suspended in 2015. The yield initially will likely be insignificant with a main focus on share repurchases. Baytex Energy bought back around 24 million shares last year, representing 4.3% of the outstanding shares.
Valuation and conclusion
Baytex Energy stock has largely been on a downtrend since November 2022. While macroeconomic tensions weighed on oil prices, Baytex looks fundamentally well placed and still looks attractive at current levels. Its improving balance sheet and earnings growth visibility make it an appealing bet in the current environment. If oil prices continue to ride higher, BTE will likely outperform.
On a valuation front, BTE stock is currently trading five times its earnings and four times its free cash flow. This looks discounted compared to peers. The valuation multiple should expand, given its solid operational and financial performance. Ranger Oil acquisition gives Baytex scale, which will likely accelerate its free cash flow growth for the long term.
