Before I argue that the intrinsic value of Penn West Exploration (NYSE:PWE) is much greater than the current valuation assigned by Mr. Market, I want to make the following cautionary statements:
1) I am bullish on future oil prices. From now on, I believe world oil prices will average $100/bbl or more (with plenty of volatility). If you do not believe this, then Penn West may not be a stock you want to own.
2) There does not appear to be any near-term catalysts for Penn West. If you are a short-term trader, then Penn West is not for you.
3) My investment thesis for Penn West is all about its discount to intrinsic value, and I don't particularly care about the juicy 10% dividend. A short-term drop in oil prices could jeopardize the dividend, and I make no prediction about its sustainability. (However, my father loves dividends, so I convinced him to invest some of his portfolio in Penn West.)
The intrinsic value of a stock is the discounted value of the cash that can be taken out of a business during its remaining life. The before tax present value of Penn West's future cash flows discounted at 10% (PV10) for its proved reserves (74% oil and natural gas liquids) is equal to its current enterprise value (market cap + debt) ,which are both approximately $9B. Everything else listed below is free!
Probable reserves - PV10 = $2.9B
Net best estimate contingent resource in the Cardium of 553 million barrels of oil
Net best estimate contingent resource in the Peace River Oil Partnership of 473 million barrels of bitumen
Slave Point contingent resource report is expected the end of the first quarter
But wait, there more. Only 21% of Penn West's proven + probable reserves (616 million barrels of oil equivalent, of which 70% are liquids) are booked using the new horizontal multi-stage fracturing technology (HMSF). The other 79% of its reserves are booked using old vertical well technology. HMSF will not only drain more oil and gas in the current target areas, but it will also turn the historically non-economic halos around legacy oil and gas pools into economically viable areas. Furthermore, as oil and gas extraction technology continues to improve, you also get a free call on future technological advances as applied to Penn West's 6 million acres in the Cardium, Viking, Swan Hills, Slave Point, Spearfish, Cordova, Peace River, Duvernay, and other formations.
If you are interested in learning more about the company, I advise you to watch its 2-1/2 hour Investor Day webcast from October 17. In the webcast, the company more fully describes the opportunities, demonstrates an understanding of its challenges, and outlines how it plans to allocate capital intelligently. Much of the future cash flow "iceberg" is submerged and can't really be estimated, but I know that it is there, it is big, and it is free.