Penn West Buffers Its Balance Sheet

Hold-rated Penn West Energy Trust (PWE) completed a surprise offering of new units on February 3, following an announcement on January 30. Management’s action appears prudent under the circumstances and adds assurance that the trust will survive tough times to be in a position to prosper when economic growth resumes. An increase in equity matching a corresponding reduction in debt has a neutral effect on McDep Ratio. Yet, the resulting immediate reduction in stock price after the announcement reduces already low McDep Ratio and makes the deal more attractive to new buyers.

Meanwhile, as industry conditions have evolved, Enerplus Resources Fund (ERF) is looking stronger than PWE in our analytical framework with a lower McDep Ratio, only nominal debt, similarly low unlevered cash flow multiple (EV/Ebitda) and a lower, but more sustainable, distribution yield.

Debt Capacity Influenced by Hedging and Resource Value

PWE’s ratio of debt to present value of 0.26, down from 0.27 last week, normally would not be a great concern considering our traditional borderline debt limit of 0.50. Moreover, four stocks in our coverage of 17 income and small cap issues have higher debt than PWE.

Trusts and companies with higher debt also tend to hedge oil and gas prices with financial counterparties. In the case of Linn Energy (LINE), we understand that the market value of such derivative contracts at the end of 2008 may have the effect of reducing the partnership’s debt to PV ratio by our calculation from 0.52 to perhaps 0.30. Not fond of derivatives, we like to see management cash out of hedges while values are high and use the proceeds to reduce risk by paying down debt. We are pleased to see that Penn West management has done some of that and may do more.

While hedges may mitigate debt concerns, fears of lower present value may accentuate them. Though we use $75 a barrel in our calculation of PV, a median McDep Ratio of 0.6 for small cap and income stocks implies that investors may be acting as though the long-term price were $45 instead. In that case, a debt to PV ratio of 0.30 would become 0.50. PWE has increased its cushion against that possibility. We hope the timing of PWE’s stock offering signals the bottom of stock price for years to come.

Originally published on February 6, 2009.

Comments

[silverwood:]

" We hope the timing of PWE’s stock offering signals the bottom of stock price for years to come."
AMEN, BROTHER!

Mar 04 12:29 PM

[Steve Ward:]

Oh Great, PWE holders now have less debt but more share dilution with a declining production profile.
What PWE giveth, PWE taketh away.

Mar 04 08:03 PM

[zayttrader:]

Whatever the case, it's fun to compare LINE to the stocks you've been recommending over the last year. Looks like it's beaten them by about 40%.

Mar 06 04:41 PM

[einstein p ...:]

I own LINE and PWE, among others in the space. Canadian and American oil and natural gas companies are vital to the long term national security and financial future. At some point in the future, especially if oil prices remain depressed, our dependence on foreign oil will send the prices soaring, which would in turn lead to hyper inflation and take these stocks significantly higher. We may look back at these prices as the bargain of a lifetime.

Mar 13 10:52 AM