Penn West Energy: Too Good to Be True?

Penn West Energy Trust (PWE) is a Canadian-based company engaged in acquiring, developing, exploiting, and holding interests in petroleum and natural gas properties and assets. 43% of revenue is from natural gas and 57% is from crude oil.

According to a Scotia Bank report released on 3/13/09, though Penn West’s forecasted P/E for 2009 is 35, its Price/Cash Flow is only 3.2, much lower than the previous four years' average of 4.5.

This financial crisis is all about Balance Sheet. There doesn’t seem to be fundamental demand-supply imbalance problem. That’s why this week the market was up around 10% when government looked at relaxing “Mark to Market” rules. Though it might take much longer to recover, as long as a company has a strong balance sheet, it should be able to weather the storm.

The following table (from PWE's latest quarterly report) outlines estimated future contractual obligations for Penn West’s financial liabilities as at December 31, 2008. As you can see, the earliest debt due is $2.56 billion in year 2011.

Source: Yahoo Finance

Penn West recently announced a reduction in monthly distribution to unit holders from $0.34 per unit per month, a sustained level for 35 months, to $0.23 per unit per month. With 385 million unit holders, that is over $1 billion cash-outflow for 2009.

Compared to 2008, Penn West’s 2009 capital program was reduced significantly to between $600 million and $825 million. Assuming 2009 average prices of $45.00 per barrel for oil, $5.50 per GJ natural gas, the company believes that it can fund capital programs and distributions with internally generated funds flow.

With 28% yield, is it too good to be true? January 2009 car sales in China were more than in the U.S., the first time in history. In February China’s car sales were up by 25%. If you believe oil and gas prices will stay at this low level for a long time, then probably it is.

Disclose: Long PWE.

Comments

[mc2406:]

I think there are many other Canroys in better shape than this one. Also, good luck with 2009 projections using an average of $5.50 per mcf natural gas.

Mar 15 10:50 AM

[Deadeye:]

I certainly did not understand the last sentence of his statement. He says if you yhink prices will stay low, they will.Well, if that's so, lets's just think prices will go up. Then we can all be ok.

Mar 15 10:51 AM

[erewhonman:]

Elliot, two points concerning exchange rate. Canadians buy CanRoys as well so its only a problem for Americans. Secondly, I like the $Can going forward much more than the $US at these rates.

Mar 15 11:00 AM

[silver-bullet:]

Actually, this can work out to be a great hedge if the US dollar falls.


On Mar 15 10:29 AM elliot_mllr wrote:

> Regarding Lee 99's comment, some Canadian royalty trusts have already
> converted to C corporations without reducing distributions because
> of accrued tax pools. This is the case with Crescent Point, which
> is the best managed of the trusts, and has large Baaken reserves
> and production (very light and sweet). And the 15% Canadian withholding
> tax is creditable against US taxes if the units are in a taxable
> account. The real problem with all Canadian dividend paying entities
> now is that the Canadian dollar is only about 77 US cents, which
> means that the gross distribution a US unitholder receives is only
> 77% of the nominal amount denominated in Canadian dollars. Yield
> has to be downward adjusted for that fact.

Mar 15 11:42 AM

[a. palmer jr.:]

I bought PWE a few months ago thinking it was probably too good to be true. I received the higher dividends for a short while then last month they were cut. Of course the Canadian dollar also sank some which didn't help. Next the Canadian government is going to tax the company as a corporation in 2 years. If too much more happens to this investment I might as well sell, but the price has also dropped to unsellable prices. The only thing left to do is wait, I guess.

Mar 15 12:08 PM

[yellowhoard:]

With Mexican oil production declining and the political situation deteriorating, Canada stands to benefit from filling this hole in our supply chain. I don't know about the timing, but PWE could be a fabulous core holding as the US dollar enevitably declines versus the Canadian dollar.

Mar 15 12:25 PM

[marinsunshine:]

Trillions in stimulus translate into deteriorating value of financial paper in favor of appreciating hard assets. It may be difficult to envision inflation at this junction, but down the road that's exactly what will happen-we just don't know exactly when.

Mar 15 12:26 PM

[Hendrick3:]

What is not mentioned is that PWE has hedged its natural gas price with a base of $6.50 on a significant portion of production. They also have hedges on crude oil that gives them high prices (around $80) on 30000 BOE equivalent. The tax pools they have amassed should allow them to avoid taxes until 2014. I believe they will sustain their payouts although even if they cut further to be conservative, they are well positioned to see great returns in the long run. They are a steal at this price.

Mar 15 12:43 PM

[blanco-dee:]

One thing to remember about this company is their interests in coal sands, which last year seemed great, now there are "environmental" concerns involving water use, footprint, CO2 release, and now this position of future development is in question.

I have been a long time investor in this trust, back from the days of NCE Petrofund, and Jim Flaherty should go down in history as the worst financial officer in the Canadian government in history, dealing a serious blow to teachers pension funds (and many other retirement and investment funds) in a single day, the Halloween surprise that saw Canadian Royalty Trusts lose over 30 billion in market capitalization in a single day.

They have enough tax credits which will aid in their transition from a trust to lord-knows-what, maybe a master limited partnership which will still benefit shareholders - though the development of oil sands may fall into question in the coming months,

good luck with your investing

BDO

Mar 15 12:46 PM

[Oraclepkwy:]

I personally think there are better trusts to invest in than PWT, such as Baytex (BTE on NYSE and BTE.UN on TSX). I happen to be long both PWT and BTE but feel that an investor has less exposure in Baytex. As such, I am adding to my Baytex holdings whenever there are large pullbacks but will simply freeze my PWT holdings. Baytex is already planning for its 2011 conversion unlike many of the Canadian trusts.

Mar 15 01:42 PM

[Steve Ward:]

Tax credits only shelter the Canroy from taxes, not the American investor. In 2011 Penn west states that American with holding jumps from 15 percent to 23 percent.

Ultimately, PWE gets boght out by CNR for a lot less than most of its American unit holders paid for the units.

Why CNR? Management at CNR owns a chunk of PWE that's why?
Why at a cheap price? The on comming debt, that's why?
The other blogger was right, buy Crescent Point.

Mar 15 01:45 PM

[whisperonth...:]

I'll take CRT over PWE any day. Although the dividend is currently lower than PWE's dividend, they go higher most of the year. And no Canadian taxes are taken out. And there is a limit to the amount of Canadian taxes that balance against the withholding here. Google charts show the American equivalent for the dividend on PWE (at least they do in the US) so you can find out without having to get out your calculator. And if oil and gas trusts are your thing, there are several of them that are US-based. Keeps things nice and simple. In fact, search SeekingAlpha - there was an article done on US-based trusts not too long ago.

Mar 15 02:57 PM

[oilsands:]

User213076 writes "Tax credits only shelter the Canroy from taxes, not the American investor. "

Tax CREDITS are appicable to US taxes as a bottom line credit, not a deduction. If you owe $8,000.00 to the IRS, and you have a 1500.00 (US) credit from the Canadian withholding, then that $1500.00 US is subtracted from the $8,000.00 you would otherwise have to pay the IRS, so your actual IRS payment would now be $6500.00, not $8,000.00.

That is the benefit to US investors based on the US-Canadian tax treaty. I love it; an automatic savings toward my tax bill.

Mar 15 02:58 PM

[Marc Courtenay:]

Perhaps that is the same dilemma many of us who still own some PWE face. I appreciate this article as it has helped me face some realities about PWE. I know it isn't exactly comparing "apples to apples" but if you want to see how far a generous dividend-yielding stock can drop just take a look at APL. Canroys and MLPs are very hard investments to accurately analyze and make predictions concerning.


On Mar 15 12:08 PM a. palmer jr. wrote:

> I bought PWE a few months ago thinking it was probably too good to
> be true. I received the higher dividends for a short while then last
> month they were cut. Of course the Canadian dollar also sank some
> which didn't help. Next the Canadian government is going to tax the
> company as a corporation in 2 years. If too much more happens to
> this investment I might as well sell, but the price has also dropped
> to unsellable prices. The only thing left to do is wait, I guess.

Mar 15 04:57 PM

[ArtfulDodger:]

These are American Gas Trusts that pay good dividends, have good management, and good balance sheets: DOM & SBR,

They may be worth a look for some of you.

Mar 16 02:08 PM

[einstein p ...:]

OPEC decided not to cut further citing "concern" for the world economies. Most likely, OPEC is no longer a cohesive block, especially given the need for higher prices to break even for members such as Iran, Venezuela, and others. China is questioning the ability of the USA to make good on it's debt while we continue to print money. I like the American and Canadian oil and natural gas trust for a number of reasons.

Oil has bottomed and will likely move higher. Demand destruction will be swamped by supply destruction.

The Canadian currency should appreciate against the US dollar, which makes the Conroys a good hedge.

The companies has been hammered and are trading at or near their lows. While lower, most still pay good dividends. As oil and natural gas prices move up, so will the price of the stocks and the dividends.

I am long PWE, PGH, HTE, PBT, LINE, and PBT.

Mar 16 07:07 PM

[optionsgirl:]

How about AAV? It's got great exposure to nat gas as well as its oil. It will have tax write-offs beyond the date the tax law changes. What do others think of AAV?

Mar 16 07:41 PM

[mr freddo:]

Thanks for the analysis. Those dividends come in monthly don't they? I have stock in Reese Energy which will soon be acquired by PWE. It's a small deal but your article is timely for me as I may become a shareholder soon.

Mar 16 09:16 PM

[Andy1234:]

I wouldn't worry about the currency exchange rate.

A stronger dollar benefits the trust....as their operation are paid in canadian dollars and their barrels of oil sold in US....which means they have lower operating costs per barrel from currency differences......other... we get a higher distribution (US holders) but their operating costs increase.

Not sure which is better.

Oil is going higher in the future.

Mar 18 08:35 AM

[svosavvy:]

Thank you Andy for stating the obvious (not a bad thing), anyone who has followed these at all knows they fund their operational stuff in cad and sell their products in US currency. So it's up to you what you like: more of weaker dollars or less of stronger dollars all the same to me. Most folks think a dollar is a dollar so they like more dollars. If/when the cad bulks up vs the dollar, cost will flatten and margins will come in, ouch.
Freddo, I heard about the reese offer the other day. Arbs (probably) are slowly buying this up, its up over a buck now. Basically you are looking at 1.39 per share worth of pwe. So if you like pwe great otherwise some dummy would probably give 1.40 eventually for that reexf as volume picks up and the dumb money moves in on it. I would hesitate to buy pwe, seems to me they are committed to keeping their distribution even at the expense of serious share issuance dilution as evidenced by their previous offering to cover their last promise. Seems to me they are a hulking bureaucratic nightmare. Smart money says find a more svelte well managed canroy than these guys. When these collars run out over the next six months or so, if oil hasn't recovered they are going to get spanked. Still long and underwater a small bit of pwe, not sour grapes just realism. Despite all of this a rising tide will still take this higher just like a piece of driftwood.

Mar 19 11:58 PM