Valued at a market cap of $1.65 billion, Headwater Exploration (TSX: HWX) is engaged in the exploration, development, and production of petroleum and natural gas in the Western Canadian Sedimentary Basin and onshore in New Brunswick.
In the last 10 years, Headwater stock has returned 482% to shareholders. After adjusting for dividend reinvestments, cumulative returns are closer to 560%. Despite these outsized gains, the TSX energy stock is down 17% from all-time highs, allowing long-term investors to buy the dip. Let’s see why I’m bullish on this cheap TSX stock right now.
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The bull case for Headwater Exploration stock
In the third quarter (Q3) of 2024, Headwater Exploration achieved a record production of 20,342 barrels of oil equivalent per day, including heavy oil, natural gas, and natural gas liquids, up 13% year over year. However, its revenue rose by just 5% year over year to $151.7 million due to lower commodity prices. Comparatively, operating cash flow stood at $95.3 million, up 11% from the year-ago period.
With adjusted funds flow from operations at $84.2 million, the company spent $58.2 million in capital expenditures, which should drive future cash flow and earnings growth. The company generated a free cash flow of $0.26 million and returned $23.8 million to shareholders via its quarterly dividend payout.
Headwater started paying shareholders a quarterly dividend of $0.10 per share in late 2022 and has since maintained its payout. In 2024, Headwater aims to generate adjusted funds flow from operations of $326 million and spend $220 million on capital expenditures.
With a free funds flow of $106 million, Headwater will pay around $95 million in total dividends to shareholders. Given its annual dividend of $0.40 per share, Headwater stock currently offers shareholders a tasty dividend yield of 5.7%.
What’s next for Headwater Exploration stock?
In 2024, Headwater has allocated $135 million towards development drilling, which should help it increase production per share by 12%. It expects to grow base production while maintaining a positive working capital for strategic opportunities.
Investment firm BMO Capital Markets recently raised its target price for Headwater Exploration stock to $10 from $9 and maintained an “Outperform” rating. The adjusted price underpins BMO’s confidence in Headwater’s growth trajectory due to its significant presence in the Clearwater Formation, one of Canada’s most economical oil plays.
Headwater owns roughly 270 sections of Clearwater rights. Additionally, it has development projects in new exploration regions such as Heart River, Seal, and Handle, positioning the company enviably for future growth in production and reserves.
Focusing on low-decline natural gas production provides diversification and stabilizes cash flow generation, making Headwater Exploration a top investment choice even when economic conditions deteriorate.
Headwater stock trades at a forward price-to-earnings multiple of just 6.6 times. Moreover, given free cash flow estimates, it is valued at 15 times forward FCF, which is not too expensive, considering its adjusted earnings are forecast to expand by 27.6% annually between 2023 and 2025.
Headwater Exploration is a growth stock that continues to invest heavily in capital expenditures, which should result in higher free cash flow and dividend payouts in the future. Given average analyst price target estimates, Headwater stock trades at a 40% discount to consensus price target estimates.
