Description

Thesis

Kelt is undervalued when considering both its operating business and the substantial value of its excess Montney acreage, even at recently weaker current energy futures prices. A sale of part or all of their asset base is likely within the next one to two years, which should help bridge the valuation gap. In the meantime, Kelt's production is poised for rapid expansion in 2025, supported by improved takeaway capacity.

Kelt's appeal lies in its management's track record, high returns on incremental capital, low leverage, and an unusually large land base relative to its current production. Kelt's valuation based on current EBITDA is roughly in line with its small cap peers. However, these comparable companies exhibit slower growth and lack the extensive inventory that would be attractive to a potential acquirer.

Summary

Kelt's primary assets are situated across the northeastern flank of the Montney fairway, an unconventional oil & gas play utilizing horizontal fracking. The returns from Kelt's key production growth areas are robust with US$60+ WTI (and exceptionally high where facilities are already in place but still good when considering initial capital requirements). These returns compare favorably with premium US unconventional plays. Compared to other areas of the Montney, Kelt's production profile is generally more liquids-rich but less pressured. At current Canadian oil vs. gas prices, this is advantageous despite potentially lower total production per well.

The high decline rates inherent in unconventional oil & gas production necessitate significant capital to maintain production levels. This is rightfully acknowledged as a drawback of the business model, despite rapid capital paybacks and high IRRs. However, if repeatability and productivity can be demonstrated alongside a vast land base, the potential value of scaled development can accumulate rapidly. Additionally, Kelt's operations will continue to benefit from the maturation of their well vintages, with older wells declining at lower rates. This will reduce the average decline and, consequently, the maintenance capex required.

At Kelt's current drilling pace (~30 wells per year), they likely have 50 years or more of usable inventory across their 340k net acres (531 net sections) of Montney and 88k net acres (137 net sections) of Charlie Lake. It's generally feasible to drill 2 to 4 wells per productive Montney layer, per section, without excessive interference, and sections can have up to a maximum of four productive layers. This mismatch in scale between Kelt's current operations and their land base suggests the assets should be worth considerably more to an acquirer capable of expediting this large-scale development.

To maximize value, Kelt aims to retain the assets until the development concepts are proven and the land is well delineated. Currently, Wembley/Pipestone in Alberta is the most marketable area from this perspective. Improving takeaway capacity in late-2024 will enable a production increase, which is beneficial for the valuation in the event of a sale. Their extensive Oak/Fireweed area in B.C. is undergoing delineation, and well results in the past two years have led to upgrades in their type curves. Oak is relatively gas-heavy but exhibits high productivity. It's well-positioned to capitalize on LNG Canada (potential start in 2025 with a ramp across 2026), which should sustainably improve the relative pricing for Canadian gas. Their remaining Montney lands are productive and relatively mature but lack the development scale to be as appealing to a large acquirer. Kelt's Charlie Lake acreage has seen more capital allocation recently due to better-than-expected well performance driving attractive returns. There's room for growth here, but it remains less significant compared to their Montney lands.

Management

The management team has a long and successful history of building per-share value. Their strategy involves purchasing prospective but not fully delineated land at opportune times in the cycle, followed by appraisal and development of a production base, culminating in an eventual sale. CEO/Founder David Wilson has consistently delivered exceptional returns for equity holders at his previous entities. He started out in 1987 buying partial interests in wells through a small private company and subsequently built up Genesis Exploration over eight years from a minor initial capital base towards a C$750m sale in 2001 (having raised total share capital of C$135m and delivered a much larger return on initial investments). Then, after assembling the team who are still largely part of Kelt’s management today (including CFO, Sadiq Lalani), ran Celtic Exploration from 2002 until sale to Exxon in 2012 for C$3bn (deploying C$600m of shareholder capital and delivering a ~50x return to initial investors).

Kelt was established as a spin-off of smaller/less developed assets from Celtic as part of the Exxon deal and has adhered to the familiar strategy, aggressively acquiring land during 2015-16. The focus remains on per-share value over size and on proving the resource for eventual sale rather than maximizing near-term financial results.

Insiders own 18% of shares, salaries are relatively modest, and management has consistently participated in capital raises when building the business (not necessary since 2016), at an average price of C$6 per share. Notably, management has continued to purchase shares during periods of weakness in the years since.

Catalysts

Kelt has secured processing capacity in Wembley/Pipestone to facilitate a rapid ramp-up in late 2024. This should allow production growth to accelerate from the low teens in 2023 and 2024 to approximately 30% in 2025. This acceleration in growth should differentiate Kelt from peers trading at similar EV/EBITDA multiples, helping it re-establish a premium valuation.

More importantly, this production increase at Wembley/Pipestone should improve the valuation in a sale, as acquirers tend to apply a multiple to current production in addition to evaluating growth potential. Kelt has already been working to secure further takeaway capacity for 2026/27. M&A timing is inherently difficult to predict, but sometime in 2025 is plausible based on management's prior pattern of selling assets after a production step-up from initiating scaled pad drilling (vs. scattered delineation wells) but before the bulk of the capital expense and potential growth is realized. Comparable Alberta Montney transactions (notably SDE’s asset sale to CPG) suggest a ~C$1bn valuation is achievable in the current energy price environment based on approximate 2025 production. This would represent almost the current EV but only monetize approximately half of their portfolio by value and production.

Near-term production growth at Oak/Flatrock has been slower, with LNG Canada likely to ramp in 2026, implying it becomes a higher priority later in 2025. Progress here had also been delayed due to protracted negotiations between the B.C. government and the Blueberry River First Nations group. This appears to have been partially resolved with a January 2023 agreement, allowing for a re-acceleration of activity. Given the potential of the land base and the strategic importance as one of the few remaining small but scalable independent B.C. gas producers, it will become incrementally more important for the equity story if and when they sell the Wembley/Pipestone assets. Notably, Crew Energy, one of the only other B.C. natural gas assets potentially ‘in play’, agreed to be bought by Tourmaline at a 73% premium last month. Comparing across EBITDA, reserve audit NAV, and flowing barrel multiples would imply ~C$9 for KEL as a whole today. However, this ignores the potential of driving a higher valuation after further production growth and holding out for an improved natural gas price environment alongside LNG Canada.

Risks

Although sensitive to various regional oil/NLG/gas prices, a sustained low WTI price (US$50 or below depending on gas prices) would be most detrimental to the valuation. It would leave their large undeveloped acreage with borderline or no near-term development value. The existing production base would continue to support the maintenance capex, and the company has no meaningful net debt.

The value of undeveloped land is inherently uncertain, and poor well results would both reduce the marketable value of the assets and deliver low/negative returns on the development capital spent.

Valuation

We value Kelt based on the sum of their current operating business and their excess undeveloped land, as we anticipate the latter to be realized in the coming years through asset sales.

For the existing operations, we use a conservative 3x 2025 EBITDA at US$70 WTI and US$3.5 HH gas (~C$1,020m). This aligns with multiples for slower-growing small cap peers without large excess land and is a discount to our DCF value of a no-growth Kelt at strip pricing (which more than covers the current EV). As a reference point, in just the five-year period since their previous large asset sale (2020-24), Kelt will have spent ~C$450m in facilities, pipelines, and equipment (and more than C$1,250m on capex, including drilling and completion).

After assigning 25% of the acreage to maintain production for 10+ years and cover past depletion, we use recent transactions in nearby Montney areas for indications of the current sale value for their excess land. We estimate a conservative average for their varied areas of just over C$2,000 per acre/C$1.3m per section, valuing excess lands at ~C$700m. There is significant upside as they delineate the large Oak/Flatrock property or if a strategic premium is paid for the large, contiguous nature of their properties.

With minimal net debt, our 1-year-out valuation comes to C$8.50 per share, 40% above the current price. Unlike many resource plays, we expect the value to compound at 15-20% p.a. for several years as they grow production and reserves organically.

Catalyst

• Production growth acceleration in 2025

• Sale of Wembley/Pipestone, potentially in 2025

• The strategic value of Oak/Flatrock increasing with LNG Canada’s ramp in 2026