The last time I got really excited about the valuation of an oil producer was in October 2021.
The stock was Cenovus Energy (NYSE: CVE), and I described the company’s valuation as being insanely cheap.
Shares of Cenovus were then offering a staggering 27% free cash flow yield.
That meant if the company had wanted to, it could have paid a 27% dividend to shareholders.
Not surprisingly, Cenovus shares performed very well after that – more than doubling in less than a year.
I’ve now spotted another oil producer that reminds me of Cenovus.
The only difference is that the valuation of this stock looks even better.
The oil producer this time is Baytex Energy (NYSE: BTE).
With the recent acquisition of Ranger Oil, Baytex is focused on primarily Texas and the Eagle Ford oil formation.
For the second half of 2023, Baytex expects to produce 92,000 barrels per day (bpd) in Eagle Ford.
Other key assets for Baytex are light and heavy oil assets located in Canada, where the company produces another 60,000 bpd.
The value proposition offered by Baytex shares is extremely simple.
At the trading price of just under $6 per share as I write, the free cash flow yield for Baytex shareholders is incredible.
With West Texas Intermediate crude oil prices approaching $90 per barrel as I write, Baytex is now offering a free cash flow yield of more than 30%.
And when it comes to income investing, understanding free cash flow is crucial.
Free cash flow is excess cash that a business is throwing off.
This cash can be returned to shareholders in the form of dividends or share buybacks, or it can be used to strengthen the corporate balance sheet.
A 10% free cash flow yield is normally something I’d consider very attractive. Currently, Baytex has triple that.
And Baytex management’s plan for this excess cash has been clearly articulated.
With the recently completed acquisition of Ranger Oil, Baytex’s total net debt increased to $2.6 billion.
Until the company’s net debt is reduced to $1.5 billion, Baytex will be using 50% of free cash flow to reduce debt, and the other 50% will be directed to dividends and share repurchases.
Once debt is reduced to $1.5 billion, 75% of free cash flow will be returned to shareholders through dividends and repurchases.
The lower the debt, the bigger the dividend payout.
Given that Baytex is projected to have annual free cash flow of almost $1.5 billion at current oil prices, it isn’t going to take long to bring its debt down to target levels.
Then, more cash can be returned to shareholders.
The Value Meter rates shares of Baytex Energy as being “Extremely Undervalued.”
Baytex shares could double and still not be expensive.
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