Penn West Energy: Q3 Earnings Review

Nov.18.08 | About: Penn West (PWE)

Penn West Energy (NYSE:PWE) recently released Q3 2008 earnings.

Highlights (all figures in Canadian dollars unless otherwise noted):

  • Due to the acquisitions, y/y comparisons may be misleading so I will be focusing on changes from Q2 2008. Keep in mind prices hit records in the beginning of Q3 (US$145) and now sit under US$60:
  • Operating cash flow (OCF) came in at $1.58 per share (+21% y/y but -11% from Q2) while free cash flow (FCF) weighed in at $0.97 per share (+67% y/y, -17% from Q2).  For those who prefer funds flow, FFO per share was $1.70, +19% y/y and -15% from Q2.  Similar to last quarter, capex came in a little light at 59% of depreciation & amortization.  The company stated that 20% of capital spending focused on areas with potential for organic growth but produce no immediate results.
  • Other than the hedges falling out, the company’s balance sheet held steady. Management mentioned that the credit crisis may curtail access to capital markets but they have $1.5B available from a credit facility.  The average term of their debt is 9 years so the financial fall-out shouldn’t hit them too hard.
  • As expected, much of the hedging losses from last quarter reversed into big gains in Q3.  Net prices realized came in at $71.54 per BOE, down 5.4% from Q2.  Netback margins keep sliding, down to 52.1% for Q3 from 54.6% in Q2 and 61.8% Q3 2007.  I’ll be interested to see what these look like after the big drop in prices and as capacity gets reduced, which should alleviate labor cost pressure.
  • In keeping with recent patterns, production, at 191k BOE/day, fell short of projections of 195k - 205k BOE/day, ostensibly due to unplanned maintenance activities.

Frankly, this is kind of an uninteresting earnings report from Penn West as it’s looking back when the items of interest are rooted in current conditions.  The average oil sales price was $110.45, to give readers an indication of how much circumstances have changed.  Nevertheless, management did narrow the gap on its standardized distribution ratio as FCF almost covered distributions (and did cover cash distributions).

Management did give a lookahead as they cut 2008 FFO from ~$2.9B to $2.6B.  2008 capital spending should remain unchanged while 2009 capex is projected at $800M, +/- $200M depending on prices.  They deferred on any income projections due to current market dislocations.

Last quarter, I regrettably stated, “It’s probably not too risky to wait to see how he [COO Murray Nunns] does with unit prices at these levels (US$27-$28) and the distribution safe as long as oil is in triple digits.”  The stock has dropped near 50% since then but the high yield helps cushion that blow.

With oil prices now in below $60, I am concerned about Penn West’s ability to maintain its current state.  The board has already declared dividends to remain steady through year end but if PWE already had trouble sustaining distributions and capex from operations, management will have to address a 60% drop in energy prices combined and more expensive debt.  If there’s any sizable Santa Claus rally, I may seriously consider selling my units.  Otherwise, I look forward to their next earnings report.

Here are the performance measurements going forward:

  • Hit guidance:
    • “Slightly below” 195k boe/day (195k - 205k boepd production for 2008)
    • $2.6B FY 2008 FFO [$2.8B - $3B FY 2008 funds flow ($7.40 - $7.90 per unit basic)]
    • $1B capex
  • Organic growth in reserves.
  • Execute their debt management program. Previously, the company announced plans to sell $200M - $300M in assets to pay down debt as well as terming out an additional $500M. While they have been rolling into long-term debt, I haven’t seen any asset sales. In any case, management stated a goal of $400M - $500M debt reduction (if oil is over $105/bbl).
  • Increased netback margins as hedges roll off their book. This seems highly unlikely with prices dropping off and management, once again, on the wrong end of the hedging game.  However, PWE did collect $123M cash by monetizing some crude hedges in October 2008.
  • Maintain sustainable operating levels, i.e. fund capex and distributions from operating cash flow.  It is only going to get more expensive to borrow money to pay distributions or fund capex (same difference, really).

Disclosure: Author holds a long position in PWE