Davy V. Bui

Penn West Energy: More Questions Than Answers

A couple of points:

1) Maybe I'm too long-winded so people don't read to the end, but as I state above, I am still long the stock. If I have an axe to grind, it is most assuredly not to lose money. My beef with management would be to improve unitholder value, pure and simple.

2) Georealist -- If you think my posts are so inept, why waste time reading/commenting on them? There are plenty of authors on SeekingAlpha that I skip over. But thanks for at least providing some analysis behind your trolling insults this time. In response, I would say that, as an investor, it is disappointing to get "peak oil" right but not make much money on it. I'm not sure why this is hard to understand.

Here is a chart of USO (the oil futures ETF), PWE (both NYE & TSX), & CHK, another stock that I follow closely. It is dated near my entry points for both positions (around Feb 2007):

www.enlightened-americ...

I think USO may have some tracking error but it is still up over 100%. The spot price for WTI was hovering around $50 - $60 at the time and I don't remember where nat gas was -- probably around $6-$8 on Henry Hub. USO is +114%, CHK is +84%, PWE is +14.5% and PWT.UN is -4.5%, not including dividends. From this, it's obvious that Penn West has badly lagged the oil bull, even if you include 15% for dividends. It's also obvious that all of the capital appreciation was due solely to the Canadian dollar strength, as shown by the 19% spread between the US and Can listed stocks for Penn West. If you did the work, you'd also see that PWE lagged other energy trusts like PGH, AAV and even PDS. So if you want to criticize me for picking a lousy stock when I could have just bought the commodity and saved myself the trouble, that's valid and something I'm already asking myself. But I'm not sure where you're coming from -- the facts are the facts.

Now I guess there's a chance that PWE could catch up, which would mean big returns from here and that leads me to Jack Yetiv.

Jack, I don't listen to conference calls live. In fact, I prefer to read transcripts whenever possible as it saves me time. I also try to find companies with good management so I don't have to worry about listening to conference calls live. For example, I still haven't reviewed the results from Agnico-Eagle (AEM) yet.

You can find my previous research, including my entry write-up, on PWE here:

www.enlightened-americ...

As you'll see, I've had many positive things to say about PWE. My original premise was based on a few main positives, all of which are weaker now:

1) The company was covering its dividend solely from free cash flow, which is sustainable.
2) While the company was fairly valued at the time based on its booked reserves, we were getting Peace River, Pembina for free with a massive 1B barrels recovery potential.
3) The management was solid and had a good track record.

As you can see from the quarterly updates, management's performance was poor. And contrary to your statement, I don't care about hedges (or the income statement) all that much so I didn't knock them for poor earnings or the big tax hit but I do care about missing production targets, poor exploration results, etc. After all, management has no control over the price of commodities but much control over operations and that's how I try to judge them. I think we have difference of opinion here. I read your 2 write-ups of PWE and it's clear to me that we approach it very differently.

You seem to be betting on commodities prices. While I think that prices are headed higher long-term, I haven't a clue where the oil price is headed over the next month, 6 months, year and everytime I try to guess, I get it wrong. For example, I thought that oil would pull back heading into winter, as it traditionally has, but then the dollar tanked and we went to $100 oil in the off-season.

I'm looking for fundamentally undervalued companies, where if the price of oil falls back to $80, the stock is still a good value. For instance, Talisman Energy a few months ago (yes, I wrote that one up too) was a good value at $16 because its assets were undervalued even if the price of oil dropped some. Obviously, if oil goes up, the stock is better value.

Also, I think you may be missing something important with your focus on the next few quarters' earnings. The market cares more about future growth, not today's results. For resource companies, that means replacing reserves and keeping costs down. Take a look at ExxonMobil which has reported record earnings and the market doesn't care. Why? Because they can't replace reserves faster than depletion. If you are investing in an oil/gas company, one of the primary concerns should be reserves replacement, especially with peak oil.

As I detailed, PWE's reserve replacement was piss-poor in 2007. They are basically buying reserve replacement. As you mention, oil prices are high so buying oil is very expensive. When PWE buys Endev Energy to replace production, they are buying oil at a high price. That isn't creating value, IMO. The company's implicit admission that Peace River isn't happening anytime soon was a big blow to growth plans.

Finally, FCF in Q1 2008 covered 24% of the dividend, which is worse than last quarter. FCF, by definition, is the cash left over after you've paid out what's needed to keep the business going (not growing, going). You can't keep paying unitholders 2-4x more money than you have indefinitely. You can see this by the big increase in debt.

I haven't a clue about funds flow because I honestly don't know what it represents or what it's good for. So you tell me why funds flow is a better representation of PWE's financial reality than OCF/FCF. Cash is king and there's a reason why. If I didn't make it clear previously, I think this switch to funds flow is fishy and suggests they are trying to paper over deteriorating results. They never used it before and not all trusts use it (take a look at PGH). But if you decide to change your metrics, at least be upfront about it and not sneak it in and hope no one notices.

I gotta wrap this up but keep in mind, I'm still long the stock. I hope I'm wrong. In fact, I'm still betting that management will clean up their house a bit -- just a little less confident than before. If I was bearish on the stock, I would sell my whole position. But as an investor, I try to be informed about all of the risks I'm exposed to and PWE's risks have climbed a bit.

Penn West Energy Needs to Show Investors Its Worth

Thanks for the comments. BTW, I respond much faster if comments are posted to my blog as I check that more often. A few responses:

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.