The oil price has been gaining some momentum lately and is currently trading almost 50% higher than the lows of February. Does this mean we have seen the bottom and bounced on it? Maybe. I would like to think so (although I wouldn't mind seeing one additional downward move so I can get my hands on some more oil and gas shares at a discounted price).
PGH data by YCharts
In a previous article on Pengrowth Energy (NYSE:PGH) I discussed the company's health and I expressed my preference for the company's convertible debt, and today I'd like to go into a little bit more detail to find out if the company's updated reserve report is indicating an investment in Pengrowth might not be as risky as the market seems to perceive it to be.
Q1 usually is pretty important for an oil and gas producer; the updated reserve report wasn't that bad for Pengrowth
Energy investors in North America are usually looking forward to the first few weeks and months of every new year, as that's the moment companies are releasing the updated reserve reports on their oil and gas projects. It traditionally also is the moment whereby the consultants calculate the PV10s, which basically just means one is trying to calculate the expected cash flows from the properties, discounted by a discount rate of 10%.
As this happens every year, why was I particularly looking forward to the reserve reports and PV10s as of at the end of last year? Because the independent consultants traditionally also update the price deck they use for the PV calculations. And as 2015 was an annus horribilis for oil and gas, the PV10s generally take a nosedive as one is now basing the calculations on $40-60 oil in the near term rather than the $60-75/barrel used in last year's reports.
Source: company presentation
Pengrowth's reserve report wasn't too bad at all. The company was able to replace 145% of the total production in 2015 by new reserves, increasing the total 2P reserves to almost 570 million barrels of oil (which compares quite favorable with the 557 million barrels as of at the end of 2014). The increased reserves also resulted in an increased reserve life index of 25.2 years and whilst that's great, there are some things you should keep in mind. The 1P reserves, for instance, fell by almost 20% to 'just' 252 million barrels as some barrels had to be 'removed' from the reserves as they either had become uneconomic or were disposed during the financial year.
Source: company presentation
That's a little bit disappointing, but on a more positive note, I'd also like to point out almost a quarter of the 2P reserves is located in the Proved Developed Producing reserve and due to the lower capital intensity to recover the oil from the PDP reserves, this part of the total reserve estimate backs approximately 34% of the PV10 value.
What does this mean on a per-share basis?
Of course, I can just throw some numbers at you and let you deal with it, but I always try to explain what things really mean.
So, the PV10% basically is the calculation of how much the oil projects will generate in revenue and cash flow, discounted to this moment. A discount rate of 10% is pretty standard, but some (well, most) oil companies also provide a calculation with other discount rates, which allows you to play around with the data. Pengrowth has provided a NAV/share, based on a 10% discount rate.
Of course, the company can do whatever it wants and would even be allowed to use a 0% discount rate to provide a NAV/share number, but considering the oil price remains volatile and the PVs are calculated on a pre-tax basis, I would prefer to use the PV10 as starting point, and it's great to see the company indeed used this as its base case scenario as well. In the next chart, you can also see the oil and gas prices used by Pengrowth to calculate the PV10. I have highlighted the WTI price and AECO gas price on the image.
Source: press release
In Pengrowth's case, the total PV10% (on a pre-tax basis) is C$3.3 billion ($2.6 billion), of which C$1.8 billion ($1.32 billion) are based on the proved reserves (C$1.1 billion ($800 million) is being backed by the PDP reserves (proved developed producing)). After deducting the net debt and adding the in-the-money hedge book, Pengrowth says its NPV/share is C$3.75 (US$2.93). Again, this is based on the pre-tax PV10% result, and includes the probable reserves as well (which might have a higher degree of uncertainty).
But on the positive side, if you would just use the proved reserves and discount the cash flows with a discount rate of 10%, the PV would be C$1.8 billion ($1.32 billion), and after deducting the net debt and adding the value of the hedge book and other obligations, the NAV would still be approximately C$450 million (valuing the undeveloped land at zero), or US$0.60 per share.
It looks like my convertible debenture idea was a good trading idea!
That was something I was hoping for when I proposed to have a look at Pengrowth's convertible debt. I was charmed by the fact the convertible debenture was trading at just 65% of the face value of the bond and I thought the market was overestimating the risk of Pengrowth going down.
Source: company presentation
As the new reserve report is now backing my initial expectations (the PV10% of just the proved reserves is higher than the company's net debt), it looks like it was a good idea to get into the convertible bonds, as the maturity date wasn't too far off. I also was expecting the company would do 'something' with these bonds, as they were trading at a huge discount to the face value, and indeed, just a few weeks after my article, Pengrowth started an on-market purchase of its convertible debentures. Unfortunately, due to the rules of the TSX, the company can only repurchase 1/10th of the total amount of outstanding debentures (for a face value of US$10-10.5 million), but this still is a good deal. If Pengrowth would be able to repurchase the bonds at a 15% discount to par value, it would save approximately $2.2 million in interest expenses and the repayment of the principal amount. Sure, $2 million doesn't sound like a big deal, but in the current environment, every dollar helps.
And the market now also seems to realize that, as the convertible bonds are now trading at 91.5 cents on the dollar (+41% in just 2 months' time). Not bad for an investment in debt!
Pengrowth has now shown its financial situation isn't as bad as the market was expecting it to be, and I now feel very confident to hold my position in the company's convertible bonds, as I do expect to be repaid in full when the debentures reach the maturity date. I'm still a little bit reluctant to buy the common stock of the company, but the updated reserve report does show there's quite a bit of value in the company's assets.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
Additional disclosure: No position in Pengrowth's common shares, but a long position in its convertible debt