Pengrowth Energy (PGH) has been in the doldrums for a couple of years on fears that it was overpaying its dividend and carried too much debt. Management came under a lot of criticism and the stock fell from the teens down below $5 per share.
The real story was not weak management but the same forces that hit a lot of gas-weighted producers in a dividend paying model - natural gas prices fell out of bed and a shift in drilling to oil and liquids was going to take time to implement. In the case of Pengrowth Energy, the shift was to a steam-assisted gravity-drainage (OTCQB:SAGD) project known as Lindbergh as well as major surgery including a drastic cut in the dividend and a total realignment of strategic priorities.
Pengrowth describes Lindbergh in this excerpt from its corporate presentation.
AT PENGROWTH, WE ARE WORKING TO BECOME A LEADER IN THERMAL OIL, ADDING ADDITIONAL LONG LIFE RESERVES AND LOW DECLINES TO OUR PORTFOLIO
Our Lindbergh thermal property, the cornerstone of our strategy to become a sustainable energy producer, is currently in development. Rather than being located in the high-cost Fort McMurray area, Lindbergh is located in East Central Alberta. Here, we are developing this niche opportunity whose substantial upfront investment is expected to yield a production profile requiring much lower sustaining capital than conventional or other unconventional opportunities. These attributes, when combined with a low-decline rate, are anticipated to produce stable cash flows to maintain our dividend.
Many thought shareholders would suffer major dilution to repair the balance sheet, and despite very good progress in pilot wells at Lindbergh and a recycle ratio close to 2.5 to 1, Pengrowth remained out of favour. Estimates to bring Lindbergh to design capacity in phase 1 of 12,500 barrels of oil a day were on the order of $1 billion and seemed unattainable. Management planned to find the money through asset sales while keeping their efforts on reducing the relative exposure of the company to natural gas versus oil and liquids.
(Excerpt from Pengrowth corporate presentation)
Management stuck to its plans and it has delivered. Natural gas production was 267 million cubic feet per day (mmcf/day) in 2007 and in 2012 was 244 mmcf/day. Oil and liquids production (including heavy oil) by contrast grew from 36,000 barrels per day in 2007 to 45,000 in 2012 and running at about 50,000 barrels per day today. The company continues to pay a dividend, currently yielding almost 9%.
But what of the funding of Lindbergh? Last night, after the close of trading, Pengrowth announced a $700 million asset sale following about $300 million of asset sales earlier this year. The total meets management's goal of $1 billion capital raised through sale of non-core assets for 2013, and paves the way for a fully-funded expansion of Lindberg. The announcement followed yesterday's announcement that based on recent drilling at Lindbergh the company had increased its oil reserves by 51% for the Lindbergh project. And, almost as if the stars were coming into alignment for Pengrowth, the company also announced it had received Ministry of Environment approval to proceed with its Lindbergh project.
The plan for Lindbergh will see production growth to 50,000 barrels per day over 5 years if it pans out. The projected expansion should become self- funding by 2016, as shown in this chart from a CIBC review published this morning.
Pengrowth remains a levered company and therefore vulnerable to commodity price declines. However, the risk of major dilution to fund its expansion seems to have passed for the next year or two at least, and successful expansion at Lindbergh combined with continued growth in conventional oil & gas drilling could make Pengrowth truly a growth company. There are few investments that combine a yield close to 9% with a robust growth outlook in the oil patch today. Pengrowth offers investors the prospect of income and capital appreciation barring a material decline in commodity prices or major disappointments at the drill bit.