Gran Tierra Energy: Making Up For Lost Time (NYSE:GTE)

Gran Tierra Energy (NYSE:GTE) is a company that has joined my list of companies that are reducing their debt in an effort to gain market acceptance of the balance sheet. This company did a reverse stock split in 2023. The reverse stock split was followed by a bond exchange to give the company time to build cash flow (particularly free cash flow). The debt exchange has resulted in higher interest expense. But it also gives the company time to convince the market that management is serious about the turnaround effort to meet the debt market demand of a 1.0 debt ratio and the market demand for free cash flow to return capital to shareholders.

Forward Strategy

Management admits as much in their latest overall strategy outlook.

Management has noted above that they have begun to repurchase debt. What is now needed is either higher commodity prices or more profitable wells so that the free cash flow becomes significant enough for the company to demonstrate to the market that it meets the latest debt market demands.

Currently, commodity prices are on the weak side and this exacerbates the company’s situation because it has a significant quality and transportation discount due to the expense of infrastructure available in the prime operating areas of Colombia and Ecuador. This company in effect is selling prices at a discount.

Business Environment

Management in the past has also had to deal with social issues in Colombia that have resulted in production interruptions. Management currently notes that there is an agreement in place to “keep the peace”. But these agreements have a way of coming undone. That is bad news for a company that is trying to reduce its debt load.

Colombia itself and Ecuador as well need the money that this industry brings in. Generally, the business environment is supportive of the industry. However, the governments are not as effective as some other places are for doing business, and the infrastructure is likewise not what it is in the United States. So, there are some challenges to doing business in South America.

Probably the social issues that result in production interruptions from time to time are what keep the price-earnings ratios low for a company like this that does a fair amount of business in Colombia and a little bit more in Ecuador.

Debt

Management now has some time to get free cash flow to a level that handles the debt.

Management should be able to repay the debt that is coming due in the near future with the available cash flow. At the current time, most of the cash flow generated under GAAP rules is reinvested in the business.

If management is looking to move the share price, then enough free cash flow needs to be generated to allow for a suitable return of cash to shareholders. Otherwise, like many companies I follow in this situation, the stock is unlikely to budge much from its current trading range. A commodity price rise, similar to what happened in fiscal year 2022, would do wonders for the current debt due schedule. Whether a period like that happens again is anyone’s guess.

Generally, the market appears to demand free cash flow that is at least half of the debt amount. That would imply that the 2027 forecast of free cash flow is going to be important.

One of the biggest issues about debt is that it has to be serviced and paid, no matter the industry conditions. Therefore, the debt levels shown here are not advised. Cutting the debt levels in half appears to be a mandatory goal for the company (in the current debt market environment) going forward.

Since the company does business in South America, the market may demand further debt level reductions as well. This is especially true for a company like Colombia with periodic business interruptions.

Operations

The costs of operations are generally on the low side. When this is combined with the generally supportive nature of the government in the area in which the company does business, the long-term outlook appears to make the current business plan viable.

Gran Tierra is a secondary recovery expert that uses waterflood recovery heavily and is looking into using polymers in the future. Management does have some high hopes for new discoveries, as discussed in the conference call. However, the market is likely to wait for the results to show as additional free cash flow.

Summary

Management appears to be serious about converting from a reserve-based strategy regardless of free cash flow to the current cash flow model with low debt ratios that is in favor with the market. It will likely take this company time to get there. But I think the odds favor the success of management’s plan.

Going clockwise from the top, the Adjusted EBITDA has only recently gotten into a satisfactory range for the debt level. Management is going to have to demonstrate that EBITDA will remain satisfactory under more conservative assumptions. Typically, the market seems to use WTI $40 in the United States. Now, how that works in Colombia with Brent pricing is anyone’s guess. Right now, given the history shown above, management clearly has some work to do to meet any reasonable goal in this area.

Reserve metrics are something that used to be important prior to 2015. Growth is still important to the market. But that growth needs to be backed with appropriate levels of free cash flow. Right now, the previous chart demonstrates that is clearly not the case.

The market no longer wants production growth as a general rule. To the extent this gets the company the free cash flow it needs to properly service the debt in the eyes of the market, it may have been a necessity. But return of capital has taken the place of production and reserve growth as a priority in the eyes of the market.

The last graph is extremely important to the market. But the debt needs to go down more, as the market wants a current debt ratio below 1 in the current environment. Otherwise, the stock price will not be moving out of its current trading range anytime soon. Here, management has made solid progress.

All of this together makes this company a highly speculative buy that the recovery underway will succeed. The biggest danger to the company is that it will likely take a few years to bring the company into compliance with current stock market and debt market demands. A lot can happen in the volatile and low visibility commodity business in that period of time.

The stock is volatile enough as an upstream company that it may be a good trading vehicle to make money on the price swings.

Risks

The strategy of this company can use some help in the form of descent to favorable commodity prices. That is far from guaranteed. Commodity prices are extremely low visibility and very volatile. Debt, on the other hand, has to be serviced and paid regardless of industry conditions. That is a really bad combination.

The reverse stock split and the debt exchange generally mark a company that has some financial stress. Both events need to fade into the history for the stock price to receive a better valuation.

The periodic social unrest that plagues the industry, even though many times it has little (if anything) to do with the industry, is a Colombia mainstay that needs to be factored into company results until it is clear that the future has changed for the better.

A loss of key personnel would be devastating to a company like this.

Commodity prices are low visibility and very volatile. Management will be hedging to guarantee future minimum results. But hedging results are rarely valued by the market.