Penn West Energy Needs to Show Investors Its Worth 23 comments
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Penn West Energy Trust (PWE) is the sole shareholder of Penn West Petroleum Ltd. (PWPL), which is actively engaged in the business of oil and natural gas exploitation, development, acquisition and production in Canada. PWE, with increasing operating costs and worrying debt levels, needs to prove its case to investors. (You can refresh your memory with my earlier reports and and updates here.)
All results are in C$.
- Operating cash flow for the full year increased 12.2% to $1.2B, with free cash flow up 2% to $545M. Per share, OCF was down 5.4% and FCF/share came in at -14.1%. This is the result of 19% dilution due to the various acquisitions (Canetic, Vault).
- Debt increased by 51% to $1.9B, mainly due to funding capex, acquisitions and the distribution yield. Currently, distribution covers 176% of free cash flow and is trending the wrong way. Management mentioned the possibility of divesting assets to pay down $200M - $300M of debt as well as terming out an additional $500M.
- On the income statement, operating income fell 44% YOY, mainly due to a 30% bump in operating expenses and $182M in unrealized losses on their hedges. Backing out the paper loss on the hedges, operating income was down 7.2%, which is still disappointing in a year of record oil prices, but all in all, not horrible. The combination of a bigger asset base (thus higher depreciation charges) and significant hedging explains the poor income results. EBITDA was up 17% YOY. Netback margins slipped to 59.8% from 62.1% a year ago. More troubling, this number sat at 58.7% for Q4 so management will need to focus on reversing that trend.
2008 Guidance
- Capex is budgeted at $960M.
- Production targets were lowered to 195K - 205K BOE/day from Q3 2007 guidance of 200K - 210K BOE/day.
- Cash flow is projected at $2.0B - $2.1B based on par exchange rate, $80 WTI & $6.75 nat gas. This compares unfavorably to Q3 guidance of $2.0B - $2.2B cash flow based on par FX, $75 WTI & $7 nat gas.
- 40% of nat gas production is hedged through March 2009 at roughly $7/mcf and 41% of liquids production is hedged at approximately $73 per BOE on a pre-royalty basis.
Penn West is struggling a bit here and is approaching “show-me” status. Operating costs are a bit out of hand. Debt levels are climbing higher, which would not be a problem if PWE was a corporation, but as a trust with nearly $1B committed to unitholder distributions, the company cannot sustain its growth plans if payout ratios are over 100% of free cash flow.
Management signaled debt levels were becoming troublesome, with intentions to manage its debt levels as outlined above. A cut in the payout may be warranted if management cannot markedly increase cash flow in the intermediate-term. Management has guided to $2.05B cash flow with $960M capex budgeted and $977M in committed distributions.
Furthermore, the realized netback margins are trending in the wrong direction despite record high oil prices and bears close watching. They are targeting a 10% reduction in finding & development costs. Some of the high F&D costs are due to spending on Peace River and Pembina, which are long-term projects, but regardless, these costs are too high and need to be brought down.
Management has taken some steps to address the situation. They've brought in Murray Nunn as COO who has shifted the capex away from Peace River and Pembina and into more conventional E&P efforts. While this is an implicit admission that realizing value on its oil sands & CO2 assets is currently a distant prospect, it does give the company more focus.
Over the last year, management has talked a lot about Peace River and Pembina, acquired a few smaller trusts and in general grew its balance sheet without adding any obvious value. The company sounded positive on E&P prospects on some of the newly acquired acreage and is putting its money there.
I will be monitoring PWE closely going forward. If 2007 results persist into 2008, I would expect an eventual cut in the distribution, which I don’t think is priced into the stock. Here are the performance measurements going forward:
- Hit guidance, specifically a sustainable standardized distributable cash payout ratio. Using midpoint guidance, projected FCF per share for FY 2008 is ~$4.37 vs. $4.08 in distributions for a ratio of 0.93.
- Organic growth in reserves. The company has been acquiring reserves but it needs to start converting acreage into reserves.
- Execute its debt management program — selling $200M - $300M in assets to pay down debt and terming out an additional $500M.
- Move closer toward realizing value on Peace River. Following the company over the last year suggests to me that the scope of the project may be beyond the reach of the company. During the conference call, management was directly confronted with selling the project and was resistant. Management needs to put up or shut up on this prospect.
Disclosure: Long PWE.
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This article has 23 comments:
THE MOST RELEVANT STATISTICS FOR PWE HAVE TO DO WITH RESERVES...even if PWE couldn't develop all of them they remain a very valuable, saleable asset.
This reminds me a great deal of the character called Zman..he posted almost every day for months..telling us in painstaking detail why daily supply figures were SO IMPORTANT. The result..he missed the move in Nat Gas...this isn't accounting!!! This is strategic analysis..everything else is BS.
All of PWE's big oil in place resevoirs are secondary and tertiary recovery operations. That's expensive and usually lowers the ROI. That is what PWE's got to beat, thus the management change.
PWe's new CEO said as recently as March/April, that all cash flow will be used to cover the development and exploration budgets, then the dividend. If any money is left over then and only then will the debt be paid down. Of course the management could do an about face.
On the dividend, PWE is using it as an enticement, currency if you will to make acquisitions. Additionally, PWE is also touting her tax pools that should give her the ability to pay the big dividend for 2 to 3 years after the law change in 2011.
Ultimately, did you want to own PWE since the Halloween Massacre of 2006 or would rather own Crescent Point Energy Trust. CPE has a different strategy altogether and has doubled its unit price since 2006 low. The only Can Roy other than Canadian Oil Sands to do so. CPE also has large OOIP reserves and uses secondary recovery methods. CPE also raised debt and diluted shares with a bought deal. The difference, higher netbacks, lower costs and a dividend payout that makes economic sense.
Reserves are good, but if current management fails to deliver on ROI then PWE shareholders will suffer like they did last year with a total negative 7 percent return, even with the whopping dividend.
It seems inconceivable to me that dividends will be lowered given current oil and gas prices. Note that I am using oil at $100 and nat gas at $10/MCF, not their current levels which are 10-15% higher.
What am I missing?
Jack Yetiv
Also, with Saudi Arabia's recent statement that they are not going to produce more even with oil at $120, it seems likely that spot priced for oil will stay north of $100 in 2008, don't y'all think?
Jack
PWE has a fair amount of floating-rate debt. I wonder if the lower interest rate environment will lower interest payments below their guidance.
Jack
1. No significant updates on Pembina or Peace River. Management did say that Peace River needs a lot more infrastructure build-out. Sounded like it'll be awhile before unitholders see anything, especially with the shift away from the long-term projects.
2. As for the outlook on nat gas + oil, I'm as bullish as anyone else -- just read some of my other posts on my blog or here on SA. However, investing in stocks exposes one to management and execution risk. To ignore this risk is foolish and dangerous; at the very least, you have opportunity cost.
3. Steve, please don't bring up Crescent Point! That was my preferred trust but for some reason or other, I didn't open a brokerage account at Interactive Brokers and I steer away from pink sheets so I get to kick myself now as CP doubles. PWE hasn't performed horribly relative to the broader market or even to some of the major integrateds, once distributions are included but opportunity cost does hurt.
4. Jack, according to their 2007 year-end report, the majority of 2008 hedges have ceilings @ ~$79 WTI and ~$7.50 AECO. As for future prices, I expect higher prices in the long-term but anything can happen in the short-term. The summer season usually means some weakness in nat gas prices but who knows these days?
Management's projections do leave room on the upside if prices stay at current levels but don't forget that CEO Andrews lowered guidance across the board just from Q3 2007 despite record prices. What if production lags or operating costs spike which has been more norm than exception for at least the past year? Nevertheless, they should meet current guidance (easily, you suggest). If they don't, unitholders, at least this one, may wonder if management can deliver and I think the distribution may be considered at that point if they keep having to use debt to cover some of the distribution.
I'm long the stock so I'm hoping Andrews & co. will make it happen. Let's see what they say next month.
But I think they'd have to be REALLY bad not to beat and raise guidance at least a little with first qtr earnings announcement. I just don't see a dividend cut as having more than a small percentage likelihood.
Also, they negotiated to buy Vault and Canetic when oil was well under $100 (probably around $90) and gas was $7. I gotta believe they made good money on those acquisitions, and if they can fold those operations in accretively, they should also be able to save some SG & A costs by combining duplicative office and backend operations.
Jack Yetiv
Accounting for the hedges as cash flow I show they will make around 75 cents per share for Q1 2008. I include an expense of $84 million becasue they stated their target for tax reserves by 2001 is $6.5 billion and they have $5.5 billion now.
I show earnings FY 2008 to be $4.11 per share with postive cash flow of $1.2 billion after the divi and capital budget. That is huge. No problems with the divi here.
Fast forward to 2009 using the forward prices and you get massive earnings as the OTM hedges fall off. I show 2009 earnings are $5.91 per share with positive cash flow of $1.9 billion. I get this numbers assuming "NO" production growth.
Remember, PWE completed the big acquisitions the end of last year and I don't believe anybody is giving them credit for that.
AAV is a similar story.
Long AAV, PWE. Starting to short USO and OIL. I don't believe these companies have gotten credit for the money they are printing and am confident they will raise the divi if OIL prices remain at these levels. I plan on shorting NG later. However, I think it has more room to run. Will start layering around 13.50/14.00.
Looking forward to 2009 if earnings are $5.91 and their current divi is $4.08 they would have to raise their divi by $1.83 per share or .15 per month. How would a 20% divi yield sound?
To get them back to a 13% yield the stock would have to go up to around $45.
I'd have to agree regarding the price of oil. I think the "floor" will be in the $100/$105 range for the near to mid term.
Jan
Previous PWe management emphasized oil sands and Pembina as the future and and told the investor their 3.9 million acres of land holdings were "impossible" to explore in a timely manner, hence they started the farm in program.
New management is now emphasizing rock source and composition in their road shows and have started to fire up an exploration program on their now 4.1 mill acreage. Obviuosly this is what new management is there for--a change in focus from tertiary recovery to exploration.That is a significant game change. That may cost money other than what is being discussed. What is obvious is that oil sands and Pembina weren't going to stop a production slide and that can spook an investor or two.
Ultimately, it may boil down to Murray Edwards, co-founder of CNRL and the largest single shareholder in PWE at least prior to the last two trust buyouts. What does he think. But with management change, maybe he has already told us what he thinks.
Second: all our efforts and comments are over the dividend, debt levels and share dilution. The Trust model has been largely acquire and exploit not exploration. Exploration models in a trust framework hasn't worked well, emphasis on not well at all.
Vermillion has done well with it along with only a couple of others. But their dividend yield is lower, much lower than the Can Roy average. Where the investor has made big bucks with these trusts is on price appreciation of the units themselves. The average is lower because of exploration costs. The units are higher because of drilling success. They are running themselves like a corporation with a good dividend, thus another alternative model od sustainability.
PWE has a traditional trust portfolio of properties, large OOIP pools or sands. requiring secondary and tertiary recovery methods; these properties usually return a lower ROI than traditional drilling. To raise money from investors they pay a high dividend. It worked.
Now and clearly, PWE is putting the two large recovery projects on the back burner and I don't think the flame is even on low anymore.
It's exploration now. That's mangement's buzzword. The current numbers may not manner. The management change is to stop sliding production with step out drilling and exploration. It will take awhile for mangement to "sell" the idea of the benfits of a dividend cut, like a nice find on the lands that requires alot more money than anticipated. But sell it they will and when they go to a full strpout and explore program they will have to sell it to find funds to exploit in a timely fashion those 4.1 million acres. Expect a cut no later than 5 quarters from now.
PWE has changed the model.
You would be looking at a PE of around 8.80 for 2008, 6.47 for 2009, and 7.50 for 2010. That's asssuming a tax rate of 30%. I just use current production numbers of around 205,000 BOE a day. They are spending around $650 million a year on development. I'd like to think they increase production some.
How can you guys say they are going to cut the divi when they are going to have an extra billion dollars this year? Next year they have almost 2 billion because their hedges fall off and they can lock in higher prices.
Remember, they have pretty high depletion/depreciation numbers also. Free cash flow with the divi added back in. Then you get $7.20 per share for 2008, $9.20 for 2009, and $8.29 for 2010. So, in three years they'll have around $24.81. Of that, $12.24 gets returned to the shareholder in divis. I don't know what they'll do with the other $12.57. Perhaps pay down debt as that is what everybody is whining about.
There is no way they are going to decrease the dividend with energy prices at these levels.
I imagine AAV is going to have some egg on their faces as they decreased their divi last at the end of 2007 on decreasing oil and NG prices only to have them spice in 2008. They will probably have to raise their divi again.
Case in point, we should be getting the same love as PBT. They have run 50% because they flow increased earnings to the bottom line:
finance.yahoo.com/q/bc...
www.pbt-permianbasintr...
My guess is we'll get some love as investors look under the hood.
Funny though. I took a quick peek at PGH and didn't come up with as attractive numbers as PWE and AAV. This guy on fast money has recommended them and his stuff has been pretty good.
More likely, after they announce earnings and the current divi ends up at a payout ratio of 50-60%, they will use the extra money to (1) increase exploration, (2) do some more work on the oil sands, and (3) pay down debt, in that order. If they sell off some non-core properties that they got from Canetic and Vault (which they will), THAT money will go to pay down debt.
By the way, the recent announcement from Saudi Arabia is HUGE, in my view, and simply has not gotten the play it deserves. They pretty much have said they are NOT going to increase their production above their current level around 10 million b/d. I know that the BRIC countries are not going to lower their demand for cars and oil to run them, so oil is more likely to go up to $135 than down to $100.
Therefore, we can all forget about 2-digit oil prices.
In addition, gas, which is a bargain relative to oil on a BTU basis, is going to follow oil. I believe we are pretty much done with single-digit gas prices (we may break $10 here and there, but I doubt the average in 2008 or any year beyond that will be under $10.
So I just don't see a divi cut, and I do see an extra half billion dollars in PWE's coffers this year, and more than a billion extra next year.
Jack
It doesn't matter if they increase the capital budget as that will be a balance sheet item and won't impact net income.
Next year the numbers are huge. If energy prices stay the same they will have to increase the divi. I'd love to see them locking in their oil flows for next year with a collar. With next year oil numbers around $110, it would be great to see the 80/140 collar.
I believe they can maintain their divi and capital budget if oil gets down to 80 and NG stays above $7 (AECO).
It should be clear to everybody, that the 20th century with cheap oil is the past. Read the book about the oil peak! China, India and all emerging markets need energy and their people want to drive motor bikes and cars too. There are only a few region with easy accessable oil, this are the middle east, Nigeria, Sudan and these countries are unstable. Further more we have Mexico, Venezuela, Algeria, Russia and in these countries the output is shrinking!
So the only stable regions are Canada and USA. Where do you invest?
Oil prices will stay high, maybe we shall have a pull back to 75$, but I am sure we will see 200$ before we have realized what's going on.
China, India and emerging markets will buy all extra oil for their people, they want to drive motorbikes and cars too. India is going to produce a car for 2000$, China has a car for 5000$.
I just think a little bit in the future in 2010 PWE will operate still in a safe country, the world still will need energy, especally the US and Canada. So where are you going to invest: in Iran, Iraq, Venezuela, Mexico, Nigeria, Saudia or maybe better in Canada?
The dividends will grow, just wait and see.
Roly
What did you guys think of PWE's earnings announcement?
Jack