Introduction

I have been following Hemisphere Energy (TSXV:HME:CA) (OTCQX:HMENF) for several years now, and I am pleased to see the total return in the past 2.5 years was 68% which handsomely beats the total return of around 25% for the S&P 500 in the same time frame. This small oil producer continues to perform well and thanks to its robust balance sheet, it is able to use the vast majority of its cash flows to pay dividends and special dividends, which represent an important portion of the total return.

Looking back at Q1 and using that as a stepping stone for Q2

In the first quarter of this year, Hemisphere Energy produced a total of 3,133 barrels of oil-equivalent per day, with about 99% of the total oil-equivalent output actually consisting of crude oil. The company produces heavy oil, which gets sold at a discount to the WTI oil price. As you can see below, the average WTI price in the first quarter of the year was US$77.45 per barrel, and the WCS difference was just under US$20 per barrel, resulting in a WCS oil price of C$77.75 per barrel while Hemisphere recorded a realized price of just under C$74 per barrel while the average realized natural gas price was just C$2.26 per Mcf.

This means two things. First of all, the company's financial performance depends on the WCS differential. A lower differential means the company realized a higher price for its heavy oil product.

Secondly, the natural gas price doesn't matter at all. As you can see below, the revenue from the natural gas sales was C$28,000 on a total revenue of just under C$21M. This means that natural gas sales contributed less than 0.15% of the total revenue. Negligible. Even if the natgas price doubles, there will be no real impact on the company's financial performance as a whole.

As mentioned, the total revenue in the first quarter was almost C$21M and approximately C$17M after taking care of the royalty payments. The net revenue, which also takes the impact of the hedge book into account, was approximately C$16.6M.

As the income statement above shows, the total operating cost was less than C$4.1M while the total expenses, including the G&A expenses, finance expenses, and depletion and depreciation expenses were just C$7.6M. This resulted in a total pre-tax income of C$9M and a net profit of C$6.8M, for an EPS of C$0.07 per share.

The cash flow statement paints an even stronger picture as Hemisphere is benefiting from existing tax pools, which means it doesn't have to actually pay cash taxes. The operating cash flow before changes in the working capital position was almost C$12M with just C$0.2M in lease payments, resulting in an adjusted operating cash flow of C$11.8M.

The total capex was C$5.6M, and this results in a C$6.2M net free cash flow result. Divided over the current share count of 97.7M shares, this represents a net free cash flow result of C$0.0635 per share.

That's slightly lower than the reported net income, as Hemisphere is planning to grow its production rate to an average of 3,400 barrels of oil-equivalent per day. This represents a 10% increase compared to the 2023 production rate. The full-year capex budget of C$20.8M will allow Hemisphere to complete 13 development wells. Considering the Q1 production rate was just 3,133 boe/day, the average output in the next three quarters will have to be around 3,500 boe/day to meet the full-year target.

If the company would solely be interested in keeping the production stable, the total capex would be substantially lower. As a comparison: last year, the total capex was approximately C$14M for the year, which is approximately C$3.5M per quarter.

The strong oil price also bodes well for the second quarter of the year. The average WCS price was approximately US$65-68/barrel, up by about US$8/barrel compared to the first quarter of this year. This means it's quite likely the company will report a substantial increase in its net realized oil price, and I think a C$10/barrel increase isn't unrealistic. This would add approximately C$2.85M in revenue and about C$2.25M after taking the royalty payments into consideration. And as Hemisphere still doesn't have to pay any cash taxes, this would immediately benefit the net free cash flow result of the company.

The dividend and special dividends

The company currently pays a base dividend of C$0.10 per share, payable in four quarterly tranches of C$0.025 per share. But as the company has no debt, it also pays a special dividend.

In June, Hemisphere announced a C$0.03 special dividend payable later this month. And as the oil price remains very strong, the cash flow results in the next few quarters should also help the company to declare more special dividends, although it will also be interesting to see how much cash the company is earmarking for its share buyback program.

Investment thesis

I currently have no position in Hemisphere Energy anymore, as I wanted to take some money off the table in the oil sector. However, with oil at US$80 and an anticipated production increase, the company is still attractive at its current share price of around C$1.80. At US$80 Oil and assuming a US$15/barrel WCS differential, the Adjusted Funds Flow will be around C$44M, resulting in C$23M in net free cash flow after taking the C$21M capex program into account. This represents C$0.235 per share, which means that after the C$0.13 in dividends and special dividends this year, there is plenty of cash available to buy back stock. Hemisphere is currently trading at a net free cash flow yield of 11% based on US$75 oil and including the growth capex. If I would assume the sustaining capex is C$15M per year, the sustaining free cash flow yield is currently approximately 14%.

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