CEO Bill Andrews and his team at Penn West Energy Trust (PWE) have been busy as of late, reporting Q3 results along with announcing a big merger with Canetic Energy Trust (CNE). Going over results first:
- Production was marginally lower, down 1% from last quarter and 3% YOY to ~125K barrels per day (bpd). The Wildboy plant incident which impaired production the last few quarters has been addressed and production is currently at 131K bpd.
- Operating revenues and expenses came in basically flat from last quarter and YOY. Operating income is down drastically YOY though (-40%) as the company's hedges were far less effective this year. From last quarter, operating income is up 5%. Net income results were skewed by tax adjustments on both a quarterly and YOY basis.
- For the 9 months YTD, operating cash flow (OCF) is up 10% to $930M with free cash flow (FCF) down 2% at $423M. On a per unit basis, these numbers are less impressive due to dilution from the Petrofund merger. Distributions YTD totaled $642M so the company's standardized distributable cash payout ratio sits at 173%. This payout ratio is not sustainable on a long-term basis.
- Management once again lowered production guidance to the lower end of their previously reduced guidance. We should now expect 128-129K avg bpd for 2007.
These results do not come as much of a surprise. As we'll discuss later, the company appears to be embarking on a series of slightly dilutive trust acquisitions for strategic purposes. This combined with the sharp move in the Canadian dollar and the company's now ill-advised oil hedges explain the downward slope of results. Additionally, natural gas prices are fairly weak, averaging $5.86 in the quarter. Gas comprises 42% of production. Overall, Penn West averaged a realized price of $52.73 per BOE with netback of $32.60/BOE, a net ratio of 62%. This ratio is down 2.5bp from last year, largely due to the oil hedges moving against them this year.
Management did lock in a foreign currency hedge against their US$ denominated debt at a historically high rate at parity, thus partly mitigating US dollar weakness. I mentioned previously that I liked their US$475M debt placement last quarter and this lowers the effective cost of that debt. Going forward into 2008, the company has 40K bpd of production hedged at what would be unfavorable terms against today's prices. That roughly equals about a third of current production figures. I view this as a slight negative but the future is unpredictable and locking in solid cash flow isn't the worst thing in the world.
Moving away from the financials, the operational results looked pretty good. The company has brought the Wildboy plant back to full production. The Pembina CO2 pilot project is still on target for Q1 2008.
They also brought in an independent auditor who examined 20% of the Peace River asset and determined oil-in-place reserves of 1.7B barrels. Mulitplied by five, this comes to 8.5B OIP against the company's previous estimate of 6.8B OIP. The company estimates a 5-20% recovery factor depending on the recovery method. Using conservative figures of the original estimate and the low end 5% recovery factor gives us heavy oil reserves of 340M barrels. The high end 20% number gives us 1.3B barrels of reserves. The company thus far has only booked 40M barrels of heavy oil reserves so the potential for reserve growth is vast. Finally, these heavy oil reserves sit among a patch of leaseholds owned by Royal Dutch Shell, who have made a strong commitment to oil sands development. I'm not banking on a buyout from RDS but pointing out the various possibilities for value realization.
Finally, examining the pro forma numbers for the post-Canetic Penn West Energy Trust, the transaction looks slightly dilutive. The company's enterprise value and debt loads will roughly double. Its production profile will be roughly the same at 55-60% liquids. My rough projections shows BOE/share to be flat at 1.6 BOE/share with EV/BOE per share at $23.50, up from $22.18 pre-merger.
Despite the slight dilution, I am giving management the benefit of the doubt regarding their strategy going forward. Andrews has mentioned on previous occasions that during the grace period before the SIFT tax comes into effect, royalty trusts can double their equity without tax consequence. They can also combine with other trusts without having that count against this equity build-up. In effect, it appears PWE is bulking up for a big acquisition down the line before the SIFT hits in 2011. Whether this is sound strategy going forward, I can't say as I've never run an oil company. But part of my investment thesis is finding management teams I trust and PWE fits that bill. Overall, I like that they only paid a 6% premium. We'll see how it shakes out going forward.
- Future performance measurements:
- Hit guidance: (128,000-129,000 boe/d production)
- Restructure debt as opportunities present themselves
- Maintain distribution, at least until 2011.
- Develop the Pembina CO2 project on-schedule (phase 2 --> 1Q 2008)
- Verify Peace River resource numbers and complete oil production facility.
- Prime Well Program add more production.
Disclosure: Author has a long position in PWE
