If you are looking for an intermediate oil and gas company that has not attracted any interest from any SA contributor thus far despite its significant rally, you have just found it. I am talking for Paramount Resources (OTCPK:PRMRF) whose stock has risen approximately 75% since late 2012, as illustrated below:
The stock closed at C$45.05 yesterday but the next questions are: Has this rally legs? Has Paramount a blue sky potential? Does the stock merit this move? To find this, let's conduct the following thorough analysis.
Paramount Resources owns 1.2 million net acres undeveloped land in Canada's Deep Basin as shown below, targeting primarily the Montney formation:
A Weak Balance Sheet
One of my main concerns is that the balance sheet is far from stellar. Since late 2012, Paramount has been increasing its net debt while the quarterly operating funds from operations remain at very depressed levels.
The net debt was $858 million in Q1 2013 and rose to $949 million in Q3 2013 (pro forma the latest equity issue of $60 million). The net debt currently stands at $1.1 billion, after the latest senior notes offering of $150 million.
Meanwhile, the operating funds from continuing operations were just $13.4 million and $53.6 million for Q3 2013 and the nine months of 2013 respectively.
On top of that, the losses have been growing since Q1 2013. Paramount has lost $59.4 million for the nine months of 2013, and it seems to me that Paramount can not make money with natural gas below $4/MMbtu and production at ~22,000 boepd.
Another reason for Paramount's losses is the high interest that the company pays due to the high debt. Paramount paid $13.3 million and $39.5 million for Q3 2013 and the nine months of 2013 respectively. I estimate the interest to total approximately $55 million for 2013. This is obviously a pile of money for a company with annual revenue at approximately $230 million for 2013.
Last but not least, the production was 23,600 boepd in Q1 2013 and declined to 21,125 boepd in Q3 2013. According to the latest presentation, the production remained at these levels (~21,000 boepd) in Q4 2013 too.
To evaluate Paramount's valuation accurately and compare it to the peer group, I will estimate first the current market value of the company's investments. As shown at the corporate presentation linked above, Paramount owns:
1) 19.1 million shares of Trilogy Energy (OTCPK:TETZF) whose current market value is ~$500 million.
2) 54.1 million shares of MGM Energy (OTCPK:MGMCF) whose current market value is ~$10 million.
3) Paramount's Drilling subsidiary (Fox Drilling) is currently valued at ~$85 million.
4) 3.7 million shares of MEG Energy (OTCPK:MEGEF) whose current market value is ~120 million.
5) Other investments (Strategic,Westbrick, RMP, etc) are currently valued at ~$37 million.
6) Paramount created Cavalier Energy in December 2011. Cavalier is a wholly-owned subsidiary of Paramount to execute the development of Paramount's oil sands and carbonate bitumen assets. Cavalier Energy holds over 300 sections, representing approximately 200,000 net acres of Crown leases in the Western Athabasca region of Alberta.
Cavalier has zero production and zero proven reserves as of today. In the first nine months of 2013, Cavalier Energy continued front-end engineering and design work for the initial 10,000 Bbl/d phase of the Hoole Grand Rapids development along with geotechnical work and the drilling of additional source water and disposal wells. Cavalier Energy's activities are currently being funded with drawings on its credit facility.
Construction of Hoole Grand Rapids Phase 1 is dependent upon the receipt of regulatory approvals, securing funding, and sanctioning by the Board of Directors. Cavalier Energy anticipates regulatory approvals to be received by mid-2014 and continues to evaluate funding alternatives.
After all, what is Cavalier's estimated market value currently? To find this, let's see first the following cases:
A) Pengrowth (PGH) has its own SAGD project in Lindbergh that targets up to 50,000 bbl/d of bitumen production by 2019. The construction of initial 12,500 bbl/d is on time, and the first steam is expected in Q4 2014 with first production expected in Q1 2015. Lindbergh has currently 2P reserves of 143 MMbbls in conjunction with regulatory approval.
Based only on its non-thermal production and 2P reserves, Pengrowth is currently undervalued in comparison to its peers, as shown in my January 2014 article here, although the stock has risen 10% since then. This means that the market currently values Pengrowth's thermal project at zero or almost zero. The market is still in a "sit and wait" mode, until the commercial viability of that thermal project is confirmed.
B) Let's check out now Pan Orient (OTCPK:POEFF) and its SAGD project. I know Pan Orient very well, because I recommended it at C$1.68 in late September 2013. The stock lies at ~C$2 at the time of writing. My article is here.
Pan Orient has a 71.8% stake in Andora Energy that holds interests ranging from 10% to 100% in 88 contiguous sections of heavy oil sands leases in the Sawn Lake Property which lies within the central Alberta Peace River Oil Sands area.
Andora's key asset is a SAGD project. Andora has received Commercial Scheme Approval for a demonstration project at the Sawn Lake property in the Peace River Oil Sands Region under the Oil Sands Conservation Act from the Energy Resources Conservation Board (ERCB) and approval from the Government of Alberta under the Environmental Protection and Enhancement Act (EPEA).
Sawn Lake, Andora's key asset, has a best-case contingent resource of 214 million barrels of bitumen recoverable, which translates into 154 million barrels net to Pan Orient. Sawn Lake does not currently have any proven reserves, and the pilot results are expected by the end of Q1 2014.
Sawn Lake's economic viability is not clear as of today, and the market currently values the project at zero, as shown in my linked article above.
On the flip side, Maurel and Prom paid $22 million in August 2013 to buy a 25% stake in this SAGD project. So Maurel and Prom estimates that the current market value of the project (100% WI) is about $90 million.
After all, I will give this project an average market value of ~$45 million.
C) Southern Pacific Resource Corporation (OTCPK:STPJF) is another company engaged in the exploration, development and production of in-situ thermal heavy oil and bitumen production in the Athabasca oil sands of Alberta and in Senlac, Saskatchewan. Southern has two producing projects.
Southern produced 4,148 bbl/d (heavy oil and bitumen) from these two projects in Q2 FY 2014, and holds 123 MMboe of proved reserves.
It took Southern one year to reach these production levels, and the company's enterprise value is about $520 million currently.
However, Cavalier's enterprise value is far from being compared to Southern's enterprise value. Cavalier has zero production, zero proven reserves and has not even received the required regulatory approvals yet.
Furthermore, the developments in Cavalier are falling significantly behind the developments in Pengrowth's and Pan Orient's thermal projects. However, I can use the current market value for both projects as a reference point, and I will be obviously generous if I estimate Cavalier's market value at $50 million currently.
After all, here is the total estimated market value of Paramount's investments:
500 + 10 + 85 + 120 + 37 + 50 = $802 million.
Let's compare now Paramount to the following peers: Bill Barrett (BBG), Birchcliff Energy (OTCPK:BIREF), and Carrizo Oil & Gas (CRZO). All these competitors are intermediate oil and gas producers and a significant portion of their production is natural gas. Their properties are located in the US or Canada, and none of them has international presence. Bill Barrett has operations that extend from the Uinta Basin in Utah to the Piceance and Denver-Julesburg Basins in Colorado. Carrizo's properties are located in four different states, and are spread over the Niobrara, the Utica, the Marcellus and the Eagle Ford formations. Birchcliff's operations are concentrated within its one core area, the Peace River Arch of Alberta.
It must also be pointed out here that Birchcliff Energy which is as heavily natural weighted as Paramount (on a percentage basis) and operates is the same area, has been making money while Paramount has been losing money since early 2013.
To find Paramount's current enterprise value, I excluded the estimated value of the company's investments, as shown in the previous paragraph. In other words, Paramount's current enterprise value is:
$5.5 billion - $800 million = $4.7 billion.
1) Per EV/Production: Let's take a look at the table below with the first key metric:
Carrizo Oil & Gas
(~45% natural gas)
(84% natural gas)
(83% natural gas)
(~50% natural gas)
(*): Per company's estimate (as of Dec 2014).
(**): Average production pro forma the recent sale of West Tavaputs.
(***): Average production.
2) Per EV/Proved Reserves: Paramount's proved reserves are 88.9 MMBoe (1% oil, 42% liquids, 57% natural gas), as illustrated below:
Let's check out now the table below with the second key metric:
Carrizo Oil & Gas
(*): Pro forma the recent sale of West Tavaputs.
(**): Pro forma the recent acquisition in the Pouce Coupe area.
3) Per EV/EBITDA: Here is the table with the third key metric:
230 (*) (**)
Carrizo Oil & Gas
(*): Based on Henry Hub price: $3.5/MMBtu - $4/MMbtu
(**): Pro forma the recent sale in West Tavaputs.
After all, it is obvious that Paramount has currently irrationally high ratios based on the production of ~21,000 boepd. The thing is that Paramount will still have sky high ratios even if the best case scenario materializes by the end of 2014. Even if the company hits its production target of 50,000 boepd by December 2014, Paramount's key ratios will remain staggering. The gap with the peers is tremendous. To me, Paramount is the typical example of a company that I will not touch with a ten foot pole.
It must also be pointed out that Paramount's ratios are so lofty that exceed by far the key ratios of a bunch of competitors which produce more oil and liquids (on a percentage basis) than Paramount.
Reasons For The Rise
Why have investors bid up the shares of Paramount to such lofty levels? Well, here are the reasons behind the current outrageously high valuation:
1) Since early 2013, the company has been continuously touting its future projects in Musreau Deep Cut Facility and Smoky Deep Cut Facility, which has been working like a carrot for many investors. I quote an indicative sample of these "promotional" excerpts, as shown here, here, and here:
A) "Construction of the Company's wholly-owned 200 MMcf/d deep cut facility at Musreau (the "Musreau Deep Cut Facility") commenced in the third quarter of 2012 following the receipt of regulatory approval. The project continues to be on-schedule, with commissioning expected to commence by the end of the third quarter of 2013. Construction of the Musreau Deep Cut Facility is scheduled to be completed in the fourth quarter and construction of the third-party Smoky Deep Cut Facility will continue into 2014".
B) "Paramount continues to execute the large-scale development of its Deep Basin lands that will materially increase production volumes and cash flow".
C) "The Company achieved significant reserves growth in 2012 as a result of its development activities in the Kaybob Deep Basin. Further increases in reserves are expected as facilities expansions are completed and development drilling continues".
D) "To support the accelerated development of Paramount's Deep Basin lands, the Company constructed its wholly-owned 45 MMcf/d Musreau Refrig Facility, is building a 200 MMcf/d deep cut processing facility at Musreau and is participating in the deep cut expansion of the non-operated Smoky facility, which together will more than triple Paramount's current gas processing capacity to over 300 MMcf/d".
C) "The next major milestone will be the start-up of the Musreau and Smoky deep cut facilities, which will represent a major step change for Paramount, as Kaybob COU sales volumes are expected to increase more than four times 2012 levels by the end of 2014".
F) "Kaybob COU sales volumes are expected to increase to approximately 30,000 Boe/d over the first few months after startup, as the operations team optimizes the facility's equipment and processes".
G) "By late-2014, Kaybob COU sales volumes are expected to increase by over four times 2012 levels once a greater proportion of liquids-rich, 100 percent working interest Montney wells are flowing through the Musreau Deep Cut Facility, the expansion of the third party de-ethanization facility is completed and the Smoky Deep Cut Facility is on-stream".
H) "After the Musreau Deep Cut Facility starts up in late-2013, the Company will have owned and firm-service contracted natural gas processing capacity of 279 MMcf/d, which will increase to over 300 MMcf/d in 2014 with the addition of the Smoky Deep Cut Facility. Sales volumes are expected to increase to over 50,000 Boe/d by late-2014 as facility processes are optimized and the new long-term NGLs processing contracts come into effect".
2) Paramount is a heavily natural gas weighted company, and the nat gas price has doubled since late 2013. As shown in my previous article here, the cold weather, the intense speculation, the momentum and the lame assessments driven by outdated methods have inflated a natural gas bubble that has pushed most natural gas players higher over the last 4-5 months.
This unjustifiable rise of the natural gas price is illustrated at the chart below:
A Few More Points To Consider
1) Paramount's properties do not hold any significant amount of oil (based on the publicly available information as of today), which means that Paramount is destined to remain heavily natural gas weighted for the years to come.
To me, this is a significant headwind because I have a bearish outlook for the natural gas price. I believe it will remain below $4.5/MMbtu in the foreseeable future (excluding short term spikes due to weather-related reasons or other one-time events).
2) Paramount is highly leveraged. It had net debt at $949 million (as of Sept 30, 2013, pro forma equity issue). The net debt rises to $1.1 billion, when we add $150 million from the latest senior notes offering.
The company had funds from continuing operations at $53.6 million for the nine months of 2013, and was producing approximately 21,000 boepd (85% gas) in Q3 2013. Thus, it is safe to assume that the company's operating CF will be approximately $70 million for 2013.
Assuming Paramount doubles its production by the end of 2014 and hits 42,000 boepd, the estimated (annualized) CF will be approximately $140 million, since the natural gas portion of the total production remains almost unchanged and well over 80%.
Paramount forecasts a production of 50,000 boepd (barring any unforeseen events) by the end of 2014, which is 20% higher than 42,000 boepd. This translates into an estimated (annualized) CF of approximately $168 million, as shown below:
$140 million + 140 x 20% = $168 million.
However, I will be generous and I will project that the operating CF (annualized) will be $185 million (10% higher than $168 million), assuming that the best case scenario materializes and the company produces 50,000 boepd by the end of 2014.
It is clear that Paramount will face significant debt problems by 2015, because the D/CF ratio will be as high as 5.95 times ($1,100 million/$185 million), given my generous estimate under the best case scenario.
To close the gap of $730 million ($1.1 billion - $370 million) and bring the net debt from $1.1 billion down to $370 million, which translates into an acceptable annualized D/CF ratio of 2 times ($370 million/$185 million), Paramount will have either to shed a big portion of its producing assets or dilute significantly the current shareholders or a combination of the above. A fourth option for Paramount is to sell all its other investments mentioned above, that are currently valued at ~$800 million.
Paramount Resources at C$45.05 is not my cup of tea. The run in the shares has more to do with the high insiders ownership (>50%) and the corporate news-flow than with underlying fundamentals. To me, the risk of downward repricing is substantial, and I will not be surprised by a deep dive over the next months.
Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.