Penn West Energy's Reassuring Earnings Update

All figures CAD$ unless noted:
Operating cash flow held up in the fourth quarter, dropping only 2% from Q3 to $602M. Funds flow from operations (FFO) fell 26% on a sequential basis to $490M, due to changes in working capital. The standardized distributable cash ratio (basically the ability to cover distributons from free cash flow) remains elevated at 1.52 for Q4, 1.34 for all of 2008. Any figure higher than 1 has negative implications.

The balance sheet remained somewhat static from Q3, with the only notable change being some gains due to hedges as the price of oil has dropped. Subsequent to the end of the quarter, Penn West announced capital raising of $238M from a bought-deal units offering and ~$190M in asset sales. The company plans to apply proceeds to reduction of debt, which stood at $3.9B at year-end.

The income statement divulges little on the state of Penn West’s operations. Netback margins remained high at 58% despite the drop in oil prices but this doesn’t quite square with the fact that operating income, once adjusted for unrealized hedging gains, showed a loss of $2M. Full cost accounting and the high level of depreciation charges probably factors into this disparity. PWE has roughly 25% of 2009 production hedged at favorable prices, which does not assure cash flow levels for the year.

In my previous post on Penn West, I speculated on possible scenarios for the company’s cash flow in 2009. Interestingly enough, the company did not provide any financial guidance for the year, other than to project capex at $600M - $825M. However, CEO William Andrews did clarify that Penn West could maintain its current $0.23 distribution with oil prices averaging US$45 for the year.

Working backwards (assumptions: midpoint capex of $712.5M, $0.23 distributions on 390M shares, 1.25 standardized distributable cash ratio & OCF = FFO), I get projected 2009 FFO of $1.4B. This is very rough speculation and you could change some variables such as assuming management will try to live within cash flow or that FFO will exceed OCF like it does most years. The most important factor, though, is probably the oil price. Every US$10 change in oil prices equates to $190M in FFO.

I only engage in the previous exercise to get at a ballpark figure for this year’s expectations. I am relieved that my worst-case scenarios from last month are unlikely possibilities. Furthermore, the company shouldn’t have any liquidity problems as its credit line doesn’t come due until 2011.

Penn West also announced new reserve totals for 2008, which were unimpressive at 454MM BOE net proved reserves. However, the company did discuss three new prospects including the Shaunavon oil play in Saskatchewan and a new shale gas play near existing operations at Wildboy. These prospects sound promising but management has to deliver after Peace River (which is even more uneconomic in today’s conditions).

All in all, Penn West’s earnings update reassured me, despite the massive drop in its unit price. Its market price is probably wholly dependent on a recovery in energy prices but the company seems to be in position to weather sustained low prices through this year. In my eyes, management has lost some credibility over the last year or two but with the addition of Murray Nunns, hopefully they will be able to execute on their program of targeted capital spending, debt reduction and unitholder returns.

While I regret not selling my whole stake when I divested a third of it last year (let this be a final lesson — don’t let tax considerations get in the way of selling), it makes no sense to sell now. In fact, the stock could be undervalued at these levels but the uncertainty regarding the SIFT tax in 2011 precludes me from adding to the position. Perhaps management should clarify their intentions regarding Penn West’s trust status once tax loss shelters are exhausted.

Performance measurements:

• Production: 180,000 BOE per day before dispositions
• Capex: $600M - $825M
  • Higher-end target only if oil prices recover > $50
  • Execute on plans to drive costs lower for first half 2009
• 2009 FFO: $1B - $1.7B
• Reduce $3.9B debt load
• Deliver results on new prospects:
  • Shaunavon
  • July Lake
  • Pembina

Comments

[einstein p ...:]

Oil and natural gas prices have bottomed and will be heading higher over the next six months. America and Canada are two safe havens in a world filled with geopolitical landmines.

PWE under 10 is a great buy. At 8 and change, it's a gift.

Mar 01 04:40 PM

[Conan the B...:]

einstein: agree on oil and NG.

The Canadian landmine occurred a few years ago and is known. The Obama American landmine is in the process of evolving. We know that oil companies will be taxed more, we do not know whether Our MLP and Trust companies will be treated differently than in the past.

Of the two countrys, I pick Canada for royalty income until the dust settles in the USA.

Mar 01 06:21 PM

[svosavvy:]

Taking the unusually high depreciation on the balance sheet now might be a smart tactic to help shore up cash in the near term but the piper will eventually have to be paid down the road when they don't have that write off to hide behind. Given the extraordinary credit environment, it's probably smart. However, issuing more units as of late to cover your bills and distributions was not smart imho. Guaranteeing the distribution for those 3 months at 31 cents really hurt. Classic tripping over dollars to pick up dimes. I hope they are more judicious in the future. I am still long my small initial position which has shrunk to a third its value, but, have yet to see why I should average more money into this one. I like the company overall and look forward to adding to my position when I start to see smart decisions from management. I could be waiting a while given the bunch steering the ship right now.

Mar 02 10:23 AM

[athenian:]

Bui omits to mention two additional conditions (other than $45 oil) on which the company is relying when it says it can continue distributions at $0.23 for 2009. They are: natural gas at $5.50 per GJ and an exchange rate of $1.25. An average gas price of $5.50 looks very optimistic. And NG is 43% of Penn's production

Mar 02 11:00 AM

[akaralph:]

Bui is wrong when he says that a distribution coverage ratio above 1.0 is bad. Quite the contrary, the higher the coverage ratio the better. He also neglects to mention the in the last quarter PWE earned $1.04 versus analysts expectations for $.03.

He is most probably short.

Mar 02 12:43 PM

[silverwood:]

Davy Bui wrote..."While I regret not selling my whole stake when I divested a third of it last year (let this be a final lesson — don’t let tax considerations get in the way of selling), it makes no sense to sell now. In fact, the stock could be undervalued at these levels"

Davy, I agree, I'm in the same boat as you let's just hope it is not the Titanic! All Canroys traded on the NYSE are way depressed and at this point its time for a "Hail Mary". Hopefully oil and nat gas will recover in the not too distant future.

Mar 02 02:54 PM

[svosavvy:]

I also agree with the writer that a little color regarding how they will do business post 2011 would be nice. Tax pool vagaries would fall under the category of talk is cheap. In the comic stylings of ron white "I'll shake the flipper but you gotta show it to me first."

Mar 03 06:17 AM

[svosavvy:]

it makes no sense to sell now. In fact, the stock could be undervalued at these levels

I doubt davy is short on this one, I would think he would disclose a short position after stating the above.

Mar 03 06:24 AM

[BudHarvey:]

We own sever thousand shares of Peen West and we are just sitting on it. We buy stocks for the dividends so we are relatively heavy in most of the Conroys.  We have continued to purchase additional sharesfrom time to time as the stocks have decreased in price.  We fell that the oil prices are close to the bottom (approximately $35.00 USD) and these Conroy stocks should se an upturn in price and dividends before the U.S. stock market actually bottoms out and starts back up. We have watched the peaks and valleys in the Conroy stock prices as they fluctuate with the price of oil. If you really shop the market for dividends, I think that anyone could reasonably conclude that the Conroy stocks are the best for now and the future if some is looking for investments with dividend income.

Mar 03 12:27 PM

[mr.finviz:]

I agree that fundamentally PWE looks good but I think PWE is still weak technically and can get cheaper. Not trying to time the bottom but looking for signs that it won't be half of my purchase in the next 3 months.

Mar 03 03:02 PM

[Steve Ward:]

As long as PWE's production profile continues to drop, which it has, it will be a loser for some time to come.
No matter any other stat.

Mar 03 03:08 PM

[Conan the B...:]

HTE just hunkered down for the duration. Their .30 Canadian div. has just been cut to .05 Canadian.

Vertically integrated, 70/30 oil/gas.

I started wandering into the pipelines, oil shippers, LNG companies last Oct/Nov to diversify.

Whatcha going to do, WMZ, TNK, CQP. Income is hard to come by. If there was an ETF/ETN paying a decent Dividend in the Gold sector, I'd be in there with feet,arms, legs whatever.

Mar 03 04:06 PM

[Lexy:]

www.msnbc.msn.com/id/2.../

Sorry for being candid, but technicals are overridden here. There is simply way too much supply of oil, gas, and even coal. It's just a matter of time before the dividend is whittled down. The economy of the largest consumer of energy is in a death spiral with no end in sight for '09. I'd lick my wounds and move on before the waterboarding starts.

PWE is on an express elevator to hell.

Mar 04 12:40 AM

[Conan the B...:]

Lexy, thanks a lot. I own PWE too.

But, No Pain, No Gain.

Mar 04 11:44 AM

[Lexy:]

Sorry, I had a large expresso yesterday.


On Mar 04 11:44 AM paultaut wrote:

> Lexy, thanks a lot. I own PWE too.
>
> But, No Pain, No Gain.

Mar 04 07:05 PM

[Davy Bui:]

Quick point for folks so people aren't confused by some of these comments.

The standardized distributable cash payout ratio is defined by the company, not me, as cash distributions declared divided by standardized distributable cash (aka free cash flow). The number you want is less than 1. Anything over one, by definition, means the company is declaring more in cash distributions than they can generate after capital spend. The commenter above is completely wrong.

Mar 05 01:37 PM