Sometimes, the largest problem a stock has is mentioned almost by accident. The admission was hidden among the other routine questions. In this case the latest conference call had a real gem.
"On your first question Shailender, I think the liquidity issue we’re going to continue to address by asset sales. And I don’t think we've necessarily done a tremendously clear job in laying out all of the alternatives on how we’re perhaps giving you the visibility that you need or would like to have with respect to where those asset sales are."
The stock drifted lower (continuing a months long trend) during the conference call and this admission (sigh!). As discussed in several previous articles, Pengrowth Energy Corporation (PGH) has a liquidity issue that at least on paper should be easily handled. Yet the company management has allowed (or been obligated) to post a stock value destroying warning about covenant compliance in the second half of the fiscal year. Some would argue that it could have been avoided. While others argue this is simply bargaining for the best price for asset sales. The fact is that the stock price has been pummeled. The lack of a clear cut publicly disclosed plan is the culprit. Plus the threat of non-compliance is getting dangerously close. So despite management assurance that so far "everything looks good" the market is not impressed with any such comments. The lenders may not be either as negotiations with the lenders have gone on for a few months. Most likely Mr. Market wants any and all warnings removed. Page 46 of the latest annual report contains a modified discussion of the more formal warnings on the financial statements.
The real key here is a failure to communicate the game plan and all the backup ideas in case the main plan does not work. All this lack of communication and possibly planning did is invite a stock price downdraft. The price decrease really hurt the equity owners and invited the purchase of a large number of shares by a new substantial shareholder.
The announced payment of roughly one-third of the debt outstanding (to a new balance of C$1.1 billion with C$100 million due in a few months) should have in most cases eliminated the problem. The unused bank line is almost equal to the debt. But management is still negotiating with lenders about covenant relaxation. As shown below the company is still losing a lot of money and the threat of impairment charges as well as more large losses could cause a covenant breech. Plus innate profitability is probably not what it should be even after the announced operational improvements.
Now comes a disclosure that maybe the high yield market is the place to go for the remaining debt. That possibility might have been avoided with a better game plan. Earlier in the year this management was ambivalent about cutting costs. That potentially slow start wasted valuable time. Now the better prices achieved by higher non-core property sales could be wiped out by increased financing charges and penalties if management is not careful.
The company lost nearly C$300 million in the fiscal year. There was a C$350 million depreciation charge. Property gains from sales, currency exchange gains, and income tax recovery all made the picture better by more than C$100 million. Still it was a horrible result by any measure. Cash flow from operating activities was C$493 million. But of that cash flow, $424 million came from commodity risk contract settlements. That left a pittance of a cash flow from operations. Management made some cost cutting announcements that have maybe replaced half of that commodity income with operational improvements. Even if that happens, a roughly $250 million cash flow would not be very satisfactory to Mr. Market. Mr. Market is probably looking for about C$500 million in cash flow to properly service the debt and fund the capital budget.
One last point of contention. Management has stated that the Lindbergh project is one of the best out there. However, the first breakeven on this project was $46 for a barrel of oil. That is a sky high breakeven in the current environment. Currently the project is producing about 20% above the projected amount, so optimistically that breakeven can be divided by 120% to calculate a new breakeven of very roughly $38 for a barrel of oil. Management thinks that they could increase production further without investing a lot of money (compared to the initial start-up investment). That could decrease the breakeven more.
The latest corporate presentation and management statements further state that future Lindburgh expansion costs and other similar new projects have decreased about 25%. Hopefully they keep decreasing. Therefore a new estimate on future project breakeven costs of both the operating Lindburgh and proposed future projects is long past due. The way management talks up the project it may well compete with shale projects at lower prices.
Right now, operations this past year did not throw off a lot of cash. So this year management needs to demonstrate to the satisfaction of the lenders and Mr. Market that this project will generate a lot of cash as well as a lot of profits. A generous depreciation charge generated by the large up-front investment of a thermal project does not guarantee project profitability.
The fact is that Lindburgh has never been profitable and that is not unusual given that the project came online just a few years ago. These projects often take awhile to operate efficiently. The big downdraft of commodity prices certainly did not help any. Lenders are not going to grant a waiver on promises. They want proof. Right now this project does not have the track record to provide that proof because it is so new.
So to discuss a potentially C$600 million expansion when the balance sheet has a notice of a covenant violation and the project has a lack of profitability seems a bit ludicrous. It may work out, but a well defined and publicized plan is long overdue. Especially a plan that includes the latest accurate costs and cash flows. Plus, once management pays the remaining C$100 million or so due this summer, there is a couple hundred million due next year. Management has not even begun to talk about that debt even though sound financial planning usually runs two years ahead of time. So to the lenders and Mr. Market, this management appears scatterbrained. They need to fix that perception. On paper, this company should survive, but management has a lot of self inflicted wounds in the way. Now should management cure those material challenges, the reserve value of approximately C$6 per share is very enticing. But it will have to be backed up by an appropriate cash flow, or this company will go the way of Sandridge Energy (SD), Halcon Resources (HK), and many others that had valuable assets with no cash flow.
Disclaimer: I am not an investment advisor and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.