Penn West Still Shaky After Cutting Distribution

As promised, I dug a little into Penn West Energy (PWE) after the company cut its distribution. Keep in mind that PWE’s numbers are basically an unknown moving target after the huge drop in oil prices. The earnings call on Feb 19 should shed much more light on where the company stands in this tumult.

Using the company’s Q3 sensitivity estimate on the company’s recent guidance of 176.6k BOE/day (58% liquids/42% gas) and prices of US$35 oil and $5 nat gas, I get pro forma funds flow from operations (FFO) of $1.7B.

However, I don’t trust this number. I would surmise that the sensitivity estimate probably breaks down as prices near the cost of production. While I am not privy to any information regarding the company’s cost-cutting measures, it may be instructive to look at the PWE’s costs during Q3 as a guide (all figures CAD$ per BOE):

• Operating expenses: $12.49
• Transport costs: $0.49
• Financing expense: $2.91
• Stock compensation: $0.66
• Net G&A: $1.68
• DD&A: $23.12
• TOTAL COST PER BOE: $41.35

Of course, some of these costs are non-cash and a few could probably be managed lower, but it does give some indication of where the price floor may be for PWE to sustain profitability. Using my own ad hoc cash flow projections and the same price rack as above, 2009 FFO may come close $1B, if we’re lucky. Personally, I take a skeptical approach toward my investments so I wouldn’t be surprised if 2009 FFO came in anywhere from $600M (netback margin: 20%) on the high end to a cash outflow (negative FFO).

That’s a wide range, but markets are moving so fast, it’s difficult to extrapolate these figures with any confidence over such a wide price drop. Unless management is a lot more savvy than I credit them, I would use the following best, middle and bad-case scenarios if prices stay near these levels:

• $1.7B FFO best-case
• $600M FFO middle
• 0 to negative FFO bad-case (I’d guess there is some chance of seeing this).

The company’s recent guidance led investors to expect $600M - $825M in capex for 2009. Also, its current distribution of $0.23 on 390M units implies $1B in payouts for the year. Finally, PWE is carrying $2.5B on a credit facility that expires in Jan 2011, with annual interest expense on all debt outstanding running around $200M.

Those are some daunting numbers and I am bracing for further distribution cuts if energy prices don’t recover strongly. Nevertheless, I am content to hold my shares for now until I hear what management has to say next month.

Once again, these are very rough projections on my part and I eagerly await the upcoming earnings call for more color. This exercise was simply my attempt to gain some sense of where unitholders might stand in light of the company’s recent announcement.

Disclosure: Long PWE.

Comments

[jt:]

Thanks, Davy...jt

Jan 22 09:10 AM

[beabaggage:]

good analysis but I think you are forgetting hedging, I expece mgmt, which has been very good at hedging compared to the other canroys, to have put on even more hedges to get thru 09 divs. they have some that are very high from summer 08. also labor/steel/other costs are falling dramatically, then you have more potential capex cuts, plus they are selling marginal assets and paying down debt, which is very good. I am long too, div may be cut but it would be more to prepare us for the SIFT d-day, even at 15cents, usa after tax yield is high at current price. added some at 10.95 recently, and will add to PGH too when pullback, it also seems solid, probably paring back my AAV and not sure about HTE w all that debt, although refinery sure looks smart now w spreads and its proximity to energy starved western and eastern Europe!
consolidation will keep a floor under canroy stock prices, all it will take is one deal and bam, we will see pop where yields make more sense.

Jan 22 10:06 AM

[Conan the B...:]

PWE: My "favorite" CanRoy. Assets, Assets, Assets are their claim to fame, with what they have, they will survive.

2010 will be a much better year.

Jan 22 11:03 AM

[BudHarvey:]

We have been purchasing conroys for a year and, yes the asset value of the stock is down; however, the dividend amounts have not decreased at the same or similar ratio and are not really that much less than they were a year ago. With the hugh peaks and valleys in the price of oil, one may ask how theycontinue to pay dividends at the current rates each month. Also be aware that they are not necessarly sell oil and gas at the market price as they have previously contracted pricing that is high today than the market price. At the same time, the IRS tax is also 15% so that is a wash with the Canadian tax being paid currently. If you are not in the lower part of the IRS tax chart, this is less tax to pay than on other investments with, in some cased, much less yield. We have lowered our overall share price by buying some additional amounts of stock as the prices have declined. Although the dividends are a little less, by purchasing additional shares through the market turmoil, we have increased our overall income. We do not currently know of any other investments with these type advantages. We are definately in the HOLD mode presently, but would not consider moving to the SELL mode on any of the conroys and we have some shares in all of the conroys on the U.S. exchanges.

Jan 22 11:17 AM

[tk77mann:]

I agree with paultaut. Given the inevitable rebound in oil and gas prices (based on our continued dependence on these fuels plus the inflation that will be caused by the huge influx of the money supply to fight the recession), the Canroys cash flows will look very good again soon.

I am still looking for other sectors to invest in to try to fight the (huge) looming inflation since I think we will still have low consumer demand carrying on from the recession. I keep coming back to oil and gas stocks since gold, for example, is a "want" not a "need" for people. And we will still be dependent on oil and gas for another decade at least so demand for oil and gas will be there.

Jan 22 11:18 AM

[beabaggage:]

There is no money left to fund alternative energy, if Oil stays at 50-60 or less for a few years and NG 4-6$, which it could if supply is flat and demand weak, then all the wind, solar and gasification nonsense will go the way of the 70's "alt energy" push. I think this will force NG to be the alt energy of choice as we have so much of it in US and CN and offshore, then NG assets are great. that was my attraction to AAV, now getting hurt as NG is down. filled up 12 gal with a local food market discount we get here in W. Pa from our grocers, had 46c build up, so a fillup only cost me $15! cheap for sure!

Jan 22 02:02 PM

[Universal H...:]

Nice analysis, Mr. Bui. You have a great "tone" as a writer.

The bottom line is that oil is a finite resource, and will eventually go up. I agree with paultaut that 2010 (and beyond) will be better years.

Tk77Mann, your prediction that we will be dependent on oil "for another decade at least" is probably way short. I would guess more like 25 -50 years, maybe longer. We are years away from feasible energy alternatives, and of course there's also the tiny little problem that we currently have no other alternative but crude for manufacturing the broad field of plastics, including polyethylene, polypropylene, polystyrene, PVC, polyesters, nylons, etc. These synthetic polymer "commodities" are processed into films, fibers, paints, adhesives, composites (e.g., glass fiber reinforced polyesters) and the extraordinary range of plastic goods found in modern society, including the computer that you are all reading this on. Polymers are also a crucial component of other advanced technologies, and of course are an integral part of the chip and printed circuit production process.

Beabaggage also touched on another issue that will keep oil and gas as viable industries for decades to come: money, or at least taxes. The oil industry alone generates billions upon billions upon billions of tax dollars for federal, state and local governments in the form of payroll taxes, corporate taxes and direct tariffs, such as the 54 cents-per-gallon (national average) that we pay on every gallon of gasoline. It will be quite some time before the "alternative" or "renewable" energy industry is mature enough and competitive enough and profitable enough to bare a significant share of this massive tax burden. (But rest assured, our clever politicians will eventually find a way to tax the sun and the wind and the waves.)

Jan 22 05:10 PM

[nothere:]

I heard that PWE just cut 70 employees in the Calgary offices, and the next round of cuts are going to be next month with field operations. interesting...

Jan 22 11:24 PM

[svosavvy:]

The pwe dist cut has come on the heels of it sustaining this level for 3 months beyond when it should have been cutting. I generally agree with the comments posted mostly paultaut's. It is always darkest before the dawn. I would hope that canroy's would lobby the current administration and press their advantage of a difficult environment to extend the current tax structure stressing that it would be in the interest of all in the nation. Possibly, perseverate on the idea that suspension in 2011 would push canadian petrochem status into the dark ages or some theatrical theme like that and get an extension to say like 2020. if you can't benefit from economic downturns, then what's the point?

Jan 26 12:20 AM

[sr9web:]

PWE is well hedged for 2009, but the author makes some good points.

Jan 28 01:23 AM

[User 356810:]

I hedge with options. Alot of these canroys are priced right for options, like $5.00, $7.50, $10.00 or $12.50 calls.

Feb 13 07:02 PM