I will take a break from analyzing the midstream companies (major, intermediate, small) of the energy industry, to write a heads-up article about a firm that has been trying vigorously to turn things around during the last 10 months. However, it is highly recommended to all investors who are interested either in dividend paying stocks with upside potential or in good short candidates to check out here my summary from the midstream sector.
This firm is Perpetual Energy (PMGYF.PK), an intermediate Canadian oil and gas producer. The Canadian companies have become primary acquisition targets lately, with the suitors coming from Asia and the US. The Asian suitors target the Canadian expertise on horizontal drilling and hydraulic fracturing, as the production from shale fields in North America has jumped over the last three years. China has the largest shale reserves in the world but lacks technology, and this is why the Asian acquisition spree is led primarily by the Chinese companies which are keen to get the know-how for drilling in such unconventional fields.
Additionally, there are many Canadian companies with producing assets that extend from Africa to South America. The acquisition of these international players with proven production and de-risked assets, is a quick and effective strategy for Asia to quench its growing thirst for oil and gas.
Meanwhile, the US-based companies also target the Canadian territory because it has vast potential reserves and is largely under-explored.
The M&A activity
After all, let's have a quick look on the most significant deals associated with the Canadian energy players:
1) Sinopec (SHI) has made more than one deals with Canadian companies during the last years. Some of its acquisitions are below:
A) In October 2011, it bought the unconventional natural gas producer Daylight Energy for more than $2 billion. Daylight's properties were located in Canada, targeting the shale oil and gas.
B) In 2008, it acquired Tanganyika Oil, gaining access to oil producing properties in Syria.
C) In 2009, it acquired Addax Petroleum, another Canadian company with oil assets and 42.5 MMboe of proved and probable reserves in Iraq's Kurdish territory.
3) In late 2012, Malaysia's Petronas acquired Progress Energy, a natural gas weighted unconventional producer, holding a large position in the Montney shale gas play in British Columbia and Alberta.
4) In February 2013, CNOOC (CEO) acquired Nexen, gaining access to a diversity of oil and natural gas producing properties. The Nexen acquisition gives CNOOC new offshore production as well as producing onshore properties in the Middle East. In Canada, CNOOC gained control of Nexen's Long Lake oil sands project in Alberta, conventional natural gas and coalbed methane producing assets, as well as billions of barrels of reserves in the world's third-largest crude storehouse, the oil sands in Alberta.
5) The US-based companies have not resisted to the Canadian appeal, and ExxonMobil (XOM) acquired Celtic Exploration in October 2012. Celtic is a Canadian natural gas-weighted unconventional producer with significant acreage in the liquids-rich Duvernay and Montney shales in Alberta.
This vibrant M&A activity will make any proactive investor try to guess the next Canadian acquisition target. Could it be Perpetual Energy?
Things Get Better Fundamentally
The thing is that Perpetual's portfolio has a bit of everything. Perpetual holds shale gas, wet gas and conventional heavy oil producing properties along with significant acreage prospective for bitumen.
The company has changed its strategy completely since May 2012. In H2 2012, it initiated a process to sell assets and reduce its mounting debt. It suspended the dividend, it quit drilling for conventional shallow gas and directed its cash flow towards its heavy oil and liquids-rich gas producing properties.
The debt reduction has totaled $207.8 million and the asset dispositions have totaled $245 MM during the last 10 months, reducing the net debt down to $335 million currently, after the latest disposition. The vast majority of the debt is also termed out to 2015 and beyond, providing significant flexibility to the company. It is also worth noting that Perpetual has only 20% drawn on the credit facility.
The company produces 22,765 boepd (81% natural gas) currently, and holds ~62 MMboe proven and probable reserves after Elmworth disposition. With an Enterprise Value at $506 million, Perpetual trades at $22,200/boepd and $8.16/boe of 2P reserves. Both key ratios are eye-catching, aren't they?
After the latest disposition, the D/CF (annualized) ratio has also dropped down to 0.5x, if we take into account only the bank debt. This is a major improvement despite the fact that the total D/CF (annualized) ratio is still a tamer for the longs standing at 6.7x, when the total long term debt of $335 million is accounted.
It is also worth noting that the management owns 25.4% aligning their interests strongly with shareholders.
What Is Next For 2013?
Through its diversification strategy, Perpetual targets on growing its cash flow and improving the debt to cash flow ratio. The capital budget for 2013 stands at $78 million, and will be directed primarily at the company's heavy oil properties. It plans to drill 27-39 gross heavy oil wells and 5-9 gross wells prospective for wet natural gas in 2013. Who said that the heavy oil is not sexy? Those who claim it, they need to bear in mind two things:
Furthermore, there are new infrastructure projects getting built and Midwest refineries will be coming back later this year. Rail transportation is also increasing. More resilient heavy oil crude prices with smaller discounts and less volatility are expected for H2 2013, improving the pricing for the company's growing heavy oil production.
The outlook for the natural gas is not quite ugly either. The recent natural gas weekly inventory report was bullish. The weekly inventories for the last full week of March plunged 94 Bcf. The plunge was significant, bringing the inventory level below the 5-year average.
On top of the plunging inventory, the amount of rigs drilling for natural gas is at historically low levels. The recent Baker Hughes report showed that rigs drilling for natural gas plunged 29 more rigs to 389. The amount of gas-directed rigs is at the lowest since May 21, 1999. The total has dropped 76% from the all-time high of 1,606 reached in summer 2008.
The combination of natural gas inventories plunging to below average levels and decade lows in rigs directed at natural gas drilling sets up two parameters that can support the natural gas prices at the current levels.
Perpetual also holds 329,000 net acres of oil sand leases in Alberta, prospective for bitumen production. However, the company will not deploy capital on these properties during the next months, keeping them as ace up its sleeve instead.
In the meantime, other natural gas weighted players have worse balance sheets and higher key metrics than Perpetual. To prove this, here are some of its peers:
Forest Oil has negative stockholder equity, and its D/CF ratio (annualized) is 5x in Q4 2012. Despite this, it has EV at ~$2.2 billion (pro forma the latest asset sale) currently, and it is valued at $56,000/boepd and $12.02/boe of proved reserves.
2) Goodrich Petroleum (GDP) is another heavily natural gas weighted company that produces 12,000 boepd (70% natural gas), and has 55.5 MMboe proved reserves. With an Enterprise Value at $1.2 billion, Goodrich trades at $100,000/boepd and $21.62/boe of proved reserves.
Additionally, Goodrich trades well above its book value (PBV=10), and carries a D/CF (annualized) ratio at 3.5x which is not low either.
Goodrich's acreage has primarily natural gas and wet gas potential because it is mainly focused on Haynesville Shale (89,000 net acres), Cotton Valley Taylor Sand (49,000 net acres) and Tuscaloosa Marine Shale (135,000 net acres). The company does not hold a significant position in Eagle Ford Shale (38,000 net acres).
It is also worth noting that Halcon Resources (HK) had recently disappointing results and non-commercial production from its highly touted Tuscaloosa Shale acreage. Actually, Halcon Resources is a grossly overvalued company for the reasons I discussed here, while I prefer Surge Energy (OTCPK:ZPTAF) for the reasons analyzed here and here. I believe all the value seekers need to take a look at these three articles about Halcon Resources and Surge Energy which have a huge valuation gap.
I consider that it is also misleading the fact that Goodrich promotes the drilling results from one well (50% WI) of its Tuscaloosa properties producing IP-30=1,137 boepd, because this very small sample is not indicative and representative for the quality of its acreage overall.
With an Enterprise Value at $15.7 billion, Cabot trades well above its book value (PBV=7), at $107,500/boepd and $24.76/boe of proved reserves.
To me, Cabot is one of the most overvalued companies of the natural gas industry, and these key metrics above have to be an alarming note to all its shareholders.
Before this transaction, Quicksilver had a total production of 57,100 boepd (81% natural gas) and 244.5 MMboe total proved reserves. From the Barnett shale, it produced 41,200 boepd and had ~200 MMboe of proved reserves in Q4 2012. After the sale to Tokyo, Quicksilver produces 30,900 boepd and retains 150 MMboe of proved reserves in its Barnett shale.
Pro forma, Quicksilver has a total production of 46,800 boepd and 194.5 MMboe of total proved reserves (80% natural gas). With an Enterprise Value at $2 billion (pro forma), Quicksilver trades at $42,700/boepd and $10.28/boe of proved reserves, despite the fact that Quicksilver has also negative stockholder equity and D/CF (annualized) ratio as high as 9x.
After this extensive and factual comparison, I am sure that Perpetual Energy looks more attractive now, doesn't it? This is why, the potential buyers and the current shareholders of the four aforementioned companies need to re-evaluate their position, as Perpetual Energy seems to offer a better value for their money among the natural gas weighted producers.
I believe the worst are behind us, and Perpetual Energy has done a good job in putting its financial house in order. Assuming the natural gas price does not plummet from the current levels, Perpetual deserves a place in any investor's radar because a price appreciation could be in the cards.