Last time Pengrowth Energy Corporation (NYSE:PGH), was reviewed, management was guiding to approximately C$15 BOE operating expenses which is way too high. But when the second quarter was reported, operating expenses were C$12.92 BOE which was significantly below the first quarter guidance. Then management reduced the guidance on operating expenses nearly C$2 BOE to roughly C$14 BOE. While that change represents a significant change from the "we got this" tenor of the first quarter, investors are still wondering if there will be enough changes for the company to survive. Mr. Market clearly has substantial doubts.
Similarly management is now stating that they expect that the company will build a cash balance by the end of the year to between C$150 million and C$200 million. The comment may have been meant to be comforting until one looks at the long term debt structure.
Source: Pengrowth Second Quarter, 2016, Management Discussion And Analysis
At the top of the page is the calculation of the debt covenants ratios with some supporting calculations underneath that. The company is very clearly in compliance. However, it is also clear that there is not a lot of wiggle room here. A 10% to 20% swing in some of those ratios the wrong way and this company is not in compliance. In case investors did not get the message, the company paid off its bank line in this quarter so that the bank line is unused except for letters of credit. That alone usually gets rid of the most jittery member of the credit team, but it will also limit the availability of that seemingly generous credit line in the future.
Source: Pengrowth Second Quarter, 2016, Management Discussion And Analysis
As shown on the page above, there is a lot of debt coming due quickly. Usually with debt maturities, "best practices" would be to handle upcoming debt maturities or debt issues about two years ahead of time. However, the last two years have not been the best for the oil and gas industry. As a result many companies have debt issues that are as immediate as this company's issues are. But that does not make those maturities a less urgent matter. The note above shows about C$516 million coming due next year. With the company's announced plan to have a cash balance of C$150 to C$200 million by December, 2016, the primarily solution appears to be to pay part of the maturity in cash and place the rest on the bank line. After all, the bank line is C$1 billion, so why not use it? But that assumes that the ratios shown above do not deteriorate to the point where that plan of action is not possible.
"Pengrowth anticipates it will remain in compliance with such covenants for the remainder of 2016; however, if commodity prices remain at July 1, 2016 GLJ forecast pricing for WTI and AECO assuming U.S.$0.75 per Cdn$1, Pengrowth may not remain in compliance with certain financial covenants in its senior unsecured notes and credit facilities during the second half of 2017. If the Company is unable to obtain a waiver or relaxation of such covenants and is not able to remain in compliance with them, the senior unsecured notes and credit facilities may become due on demand. There can be no assurance that Pengrowth would be able to obtain a relaxation or waiver of the covenants in its senior unsecured notes and credit facilities"
In the management discussion and analysis (on the very next page, page 39) is the above statement. That is not a disclosure that is to be taken lightly. Currently, the bank line is basically unused, so the bank retains the option to leave rather than help the company out of a cash crunch. The bank probably does not want to invite a problem where there currently is not a problem. Plus the cash flow in the second quarter was only C$89.1 million. That was down from C$106 million in the first quarter. Even though management attributed this decrease to turnarounds, sales of properties, and other legitimate things, that cash flow trend is in the wrong direction. Management has a stripped down capital budget that is not sustaining production enough for any cash flow increases at the present time unless commodity prices increase quite a bit more than forecasted.
Unless things change soon, management may not meet its production goals for the year, or have enough production next year to keep the covenant ratios from changing into non-compliant territory. While management did forecast this second quarter production, there is a real possibility of the year end production being materially lower than the budgeted amount because of the very good first quarter (where production was about 9% higher).
Plus nearly all of that cash flow is coming from the hedging program which showed a C$77 million realized second quarter gain. Without the hedging, the cash flow is slightly above the break-even point. Since next year, the hedging program decreases, there is a second reason to assume that the bank line may not be available in its present form, if at all.
The convertible debt is due within a little more than half a year. Maybe the best way to handle that debt would be to make a favorable exchange offer for company shares. While that would lead to some dilution, it would also save the company cash and enable management to concentrate on the large maturity next year. In any event the current ratio is a little below the 1:1 ratio that is considered reasonable for most companies, and it will get weaker still as more debt becomes classified as current in the future. The C$516 million will be classified as current beginning next quarter based upon current information. That change in classification will strain the balance sheet quite a bit.
The company does have some derivatives to offset unfavorable currency swings. But would still have to come up with the original principal amount. Right now management's primary plan looks very shaky at best. To shore up that plan, more asset sales will be needed. Management will probably have to sell a core area to straighten this out because large dollar amounts are going to be needed quickly. Company management is warning about not being in compliance during the second half of 2017, but from the discussion above, shareholders should not be surprised if that non-compliance arrives sooner. Especially since commodity prices are dropping at the current time, caution would be the indicated way to review the prospects of this company.
While the company management has rightfully touted its success on the Lindburgh project, and celebrated the regulatory approvals to expand the project, the positive effects of this project have not overwhelmed the negative effects elsewhere. The project may have slowed the decline (or deterioration) but that is all. That declining cash flow in the second quarter points to the inability of the Lindburgh project to turn the cash flow situation around by itself. This is a very capital intensive thermal oil project that the company does not have the money to expand at the present time. So the regulatory approval may be a hollow victory.
Management has stated that they will delay drilling until commodity prices improve. But with the rest of the industry reporting ever lower break-even costs on future projects, increasing commodity prices may be a pipe dream. The increasing price scenario has been delayed several times, so there is no reason that to believe that increasing prices will help any time soon. Supply has consistently exceeded previous expectations and rapid innovation all point to more supply in the future than was expected. Plus many alternative projects can ramp up the activity levels quickly and efficiently. More and more managements are beginning to state that the new lower commodity price environment is the norm, and I have written dozens of articles about those managements. Some of the really aggressive outlooks, such as the management of Murphy Oil (NYSE:MUR) are stating that the company needs to thrive when oil prices are in the thirties. While that is extreme, the typical attitude about lower commodity prices appears to sharply conflict with the attitude of this management that higher commodity prices are just on the horizon. So the stock price of Pengrowth has taken a beating over the last few years as a result.
The company does have other properties in Canada, such as where the Montney is prospective. Several competitors are touting drilling this zone as a quick and profitable cash flow increase. Management has a different and very much minority position about several of these prospects. But the company may be able to sell some of these leases to raise the cash it needs.
Several comments have been made about a wealthy major shareholder. First those shareholders can change their minds, and investors may well read about the change too late. Second, major shareholders can be wrong. Carl Icahn and others have admitted some mistakes along the way. Clearly a lot of these wealthy individuals are right far more than they are wrong, but they can be wrong. Prospective investors who want to invest solely because a well publicized or major shareholder is or is rumored to be investing in the company do have an investment plan that could be far worse. However, most investors are advised to review the company fundamentals which in this case are really not good. Then wait on the sidelines until things turnaround (if they turnaround) and invest when the chances of success are far better.
The company could sell properties to pay down enough debt and become viable without the non-compliance warnings. Penn West Energy (NYSE:PWE) and Paramount Resources (OTCPK:PRMRF) did just that. However, it is not a path that many companies were able to use to get out of financial binds.
The stock price is so low now, that even if investors invested after a "pop in price" due to good news, the new price could well afford some decent capital appreciation. There is also the very good possibility that the stock price will back-track after the pop due to the good news.
I have written about other companies that should deliver some very good returns without all this financial drama. Granite Oil (OTCQX:GXOCF), Advantage Oil and Gas (NYSE:AAV), Tourmaline Oil (OTCPK:TRMLF), and BP (NYSE:BP) with that big dividend that is probably far safer than most realize, all promise above average returns without the financial excitement this company offers. There are investors who believe that high financial leverage and problems are necessary for giant returns. But research has shown that out of favor companies that "consistently hit singles" are the most likely candidates for a "home run" investment. So while management's attitude appears to have changed materially from the first quarter, and there is some definite movement in the right direction, there is not enough positive evidence here for a winning investment at the present time.
Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.
Disclosure: I am/we are long GXOCF.
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.