Penn West: If You're Bullish On Oil...

| About: Penn West (PWE)

Summary

Penn West can survive with oil prices at $40 WTI.

At lower prices, the risk of failure is high.

At higher prices, the upside leverage is dramatic.

I am betting on survival.

Penn West (NYSE:PWE) continues to face severe challenges in 2016. The current price of oil at around $33 U.S. for West Texas Intermediate ("WTI") could bring PWE's EBITDA to the $155 million range with funds flow from operations approaching zero.

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Source: Penn West

Leverage to oil prices is extreme. At $45 U.S. for WTI, Penn West's EBITDA doubles to the $300 million range, and funds flow would exceed the planned $50 million capital outlays by $100 million more or less.

If prices continue at the present $30 range, the company is headed for failure or major restructuring, and equity holders may be wiped out. Any investor who believes $30 oil is here for more than a year or so should bail out of PWE today.

I don't share that belief. At September 30, 2015, Penn West had $2.2 billion (Canadian) or about $1.5 billion U.S. of debt before $393 million (Canadian) or $280 million U.S. of dispositions which closed after September 30, 2015.

I expect PWE's December 31, 2015, balance sheet will show indebtedness below $2 billion Canadian ($1.4 billion U.S.), which, while still high by most measures, should be manageable if we see oil prices recover to the $40s in 2016. Penn West continues to explore divestiture of additional assets to reduce debt.

The bet on PWE is all about oil prices. If they remain in the low $30s, Penn West will struggle to survive. At anywhere north of $60 a barrel, Penn West will enjoy substantial free cash flows and have the ability to bring its debt more in line with sustainable levels.

Penn West is a high-risk stock and highly speculative. So where will oil prices unfold in 2016 and how will PWE fare? Good question. Here are some of the forecasts from reliable sources and their implications for PWE's stock:

  • World Bank has oil at $37 per barrel for 2016. Penn West struggles through another year but survives.
  • Energy Information Administration forecasts 2016 WTI at $38.54 with an improvement to $47 in 2017. PWE has the ability to pay down some debt in 2017.
  • CNBC commentator Terry Tamminen sees $70 oil for 2016. If so, Penn West stock should do very well.

The range of forecasts demonstrates the dilemma investors face, offering a range from $37 to $70 and an outlook for Penn West that could lie anywhere within or even outside of the forecast range. We just don't know.

What we do know is that the world is consuming more oil, not less, and that capital outlays to drill for oil have been cut dramatically. We also know that countries like Russia, Venezuela and Nigeria are under enormous pressure from low prices and desperate to see them rise. I believe the current "glut" is on the order of 1 or 2 million barrels a day on a base of some 95 million barrels of production. Feast can turn to famine quite quickly when oversupply is barely one or two percent.

Accordingly, I am willing to speculate that Penn West will survive, and oil prices will recover. I don't know when, but my gut tells me the recovery is no more than a year or two away. In those circumstances, I am adding to my already very long position in Penn West and in other oil-related names.

Disclosure: I am/we are long PWE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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