During the past five years, there has been a lot of disappointment over the performance of Canadian Oil and Gas companies.
One stock in particular, namely Penn West Exploration (PWE), has received a lot of attention in response to their stock price performance. Recently, a high profile executive left after merely serving a few months as executive. Furthermore, Penn West's quarterly dividend was reduced from 27 cents to 14 cents.
Be Greedy When Others Are Fearful
In considering the potential undervaluation of Penn West, I have summarized the company's operating statistics and cash flows of the last five years:
Crude Price WTI
Distribution % of FF
Share Price Performance and Distribution
In 2008, Penn West was trading around $30 and the distribution was $0.34 a month ($4.08/yr). In contrast, their share price for 2012 was trading around $14 and the distribution was $0.27 a quarter ($1.08/yr). Today, Penn West's prices are around $12.00 and the distribution is $0.48/yr. This means:
- Share Price has dropped by 65%
- Distribution has dropped by 90%
Penn West is an exploration and production (E&P) company producing oil and gas. Penn West's history shows that production was 184k boepd in 2008. A marginal drop in production was noted and by 2012, production was 161,195k boepd. However, this does not explain the size of the share price drop.
Price of Oil and Price of Gas
Oil prices have been rising steadily for the past 5 years after collapsing in 2008. On the other hand, gas prices have been dropping every year since 2008 bottoming at 2.50 mmbtu in 2012. The oil price recovery is one possible explanation for the bump in Penn West's 2011 share price, before the natural gas price drop. But from 2012 onwards, the steady price drop started to pull the share price down.
Distribution Level Was Not Rational
It is a well-known fact that several investors held Penn West responsible for their distributions - these investors were naturally upset about the distribution cuts from 2008.
Previously, Penn West behaved like a flow-through trust and their distribution dealings were even considered as acts of insanity by some investors. The elevated level of distribution may very well have resulted in a premium above its share price. In addressing this problem, Penn West has taken corrective steps and today, distributions are only $234m. This is less than 30% of Penn West's funds flow and can be considered as a comfortable level with fund flows coming off their 2008 highs.
Penn West is suffering from low natural gas prices and nothing else. Disappointment over distribution reduction may have caused some investors to sell their stock, culminating in a situation of excessive stock selling.
Penn West's current management has also been doing the right thing by reducing staff and costs. Investors should see the results of these actions in the coming year.
Today, Penn West is a rational company for the long term. It is paying a reasonable distribution within its available cash flow in the current low natural gas price environment. Production wise, this is the same company that produced over 160,000 boepd in 2008. Penn West is now able to fund Capex directly from their funds flow.
In the event that natural gas prices revert back to the mean, Penn West could experience a significant positive swing. A substantial amount of cost is fixed, meaning any natural price increase will go straight to the bottom line quickly. Buy Penn West to keep for the long term capital appreciation and get paid while waiting.