One year ago from today, Pengrowth Energy Corp (PGH) was trading at just above $10 per share. As a result of poor performance and low levels of profitability, its market capitalization was sliced in half and now stands at roughly $2.39 billion. Focusing on the fluctuations in PGH's security market price over the past two months, it is clear that its price has formed stability and now presents an attractive short-term buying opportunity. This article provides an overview to PGH's business model, highlights its operations, as well as its recent performance in the market. In addition, I will provide five reasons supporting the bull case for PGH capturing important items from its most recent operating results. To conclude, I will discuss relevant risk factors investors need to understand in order to help minimize downside risk on an initial investment.
Business Overview & Market Performance
PGH's operations focus on the development, production, acquisition, and exploration of oil as well as natural gas reserves in the provinces of Alberta, British Columbia, Saskatchewan, and Nova Scotia. Its production properties include Swan Hills Areas, Olds Area and Groundbirch, Weyburn.
Currently, PGH is trading right between $4.50 and $5 per share. Approximately 10% and 24% of its $2.38 billion market capitalization is owned by PGH's insiders and outside institutional investors, respectively. Using monthly data of PGH's holding period returns (including dividend distributions), I computed a firm-specific beta value of 1.38. This suggests PGH is only of slightly higher risk than the return of the market, which reveals a beta of 1. Also, its beta is relatively low in comparison to industry peers who display an average beta of 1.75.
Figure 1: PGH's One Year Price Graph
Five reasons to buy PGH at its current market value per share:
#1 PGH's operations reveal strong and consistent levels of production. According to PGH's most recent operating results released by management, PGH's average daily production for the fourth quarter in FY 2012 was 94,039 barrels of oil per day. This is slightly lower than the average daily production in the previous quarter, however year-over-year this figure has increased by approximately 16%. The average daily production for FY ended 2012 was 85,748 barrels, which can be attributed to the acquisition of NAL Energy.
#2 PGH is improving its operating efficiency. Since the end of FY 2011, operating costs in 2012 increased on average by 20%. However, it is important to note that in the coming year PGH is going to be fully capable of reducing operating costs through the use of existing infrastructure at the site of the Lindbergh project. Also, PGH's average oil and gas sales increased by 2% year-over-year and as a result of new projects line up this trend is expected to continue.
#3 Its position in natural gas provides significant room to increase profitability. Currently, about 45% of its revenue is from its product mix in natural gas. A rise in the price of natural gas would augment profit margins and increase free cash flow available to shareholders.
#4 Short-term gains are increasing becoming more probable and appealing. PGH's Swan Hills provides the most substantial returns for investors in the near-term. PGH is utilizing horizontal drilling to increase efficiency and so far it have proven to be effective for increasing production levels.
#5 Seven analysts that cover the stock have a six month median price target of $7.50 per share. This suggests an upside of over 50% from its current market price per share.
PGH is currently selling a portion of its assets off to maintain a stable cash flow. While this is not a bad thing, it's clear PGH has a insufficient return on assets and without changes this will continue. I strongly feel cutting the annual dividend would be a feasible option because it would enable management to alter its capital allocation. Initially, the dividend cut would signal investors that PGH's asset composition is not capable of providing a return on investor's investment. In addition, this would allow management to reallocate capital towards new projects that offer a greater return to investors. Currently, PGH's dividend yield is 10.12%, which is substantially high for a company in this industry. This yield equates to roughly $0.04 per month, or $0.48 annually. Eliminating this dividend would save PGH close to $289.1 million per year that could be allocated towards new projects. Aside from my recommendation, PGH's assets remain my major concern that investors need to consider. Poor performing assets can heavily contribute to poor profitability.
In addition, given the nature of PGH's operations it's important investors take into account the current state of commodity markets. The figure below was extracted from PGH's recent guidance report from management and illustrates a sensitivity analysis showing the price change in PGH's security price given changes in the commodity price of oil and natural gas.
Figure 2: Commodity Price Sensitivity Analysis
PGH's current share value of $4.72 poses minimal down side risk in my opinion, but the underlying issue still remains -- profitability. PGH simply needs to become more profitable. Its new acquisition of NAL Energy was not a game changer for me and PGH's assets are still fair at best. On a positive note, PGH's new Lindeberg project may be a shock to investors. PGH is using existing infrastructure to help reduce project costs. The fact that PGH did not have the opportunity to utilize existing infrastructure in carrying out the Greenfield project has me bullish on the outcome of the Lindeberg project. In conclusion, PGH is a speculative investment with high uncertainty surrounding its operations that makes the upside potential for investors abnormally high.
Sources: TD Ameritrade, Google Finance, Yahoo Finance, FinViz, & The Wall Street Journal.