Monday, July 29, 2013

This Canadian Energy Play Is Eyeing a Turnaround

Penn West Petroleum (NYSE: PWE) is one of the largest oil and gas exploration and production companies in Canada, and the stock is poised for significant growth in the near term. Although this year its shares have trailed slightly behind the S&P 500, in 2012 the stock was a disaster, showing a drop of more than 45% in the 12 months ending December, which mirrored the company’s unimpressive performance. In fact, in 2012 Penn West was the third among the three worst-performing Canadian energy producers. However, Penn West has gone through a significant overhaul and is now eyeing a turnaround.
A turnaround
Over the past few years, the company has delivered disappointing performance with little increase in production and a mounting pile of debt. In short, Penn West had been an inefficient exploration and production play. As a result, the company had had to either sell its assets to finance its capital expenditures or opt for joint ventures.
Meanwhile it continued giving the controversial quarterly dividend of $0.27 per share, which translated into a yield of more than 8% (since it was operated as an “income-fund,” which in the US is similar to an MLP and are generally high-yield investments).
However, the company is now eyeing a turnaround via a change in leadership and a cost-cutting strategy. It has significantly cut its quarterly dividend to $0.14 per share and is currently reducing its workforce by 10%. Non-core assets are being sold, which will ease the debt burden and will help the company in achieving its capex targets.
But more importantly, Penn West has gone through an executive management overhaul following the departure of its CEO Murray Nunns, who retired on the first day of the current month. He is being replaced with the former COO of Marathon Oil David Roberts. Several managers who reported directly to Nunns were replaced.
Meanwhile industry veterans Rick George, the former CEO of Suncor Energy (NYSE: SU), and Allan Markin, the former chairman of Canadian Natural Resources (NYSE: CNQ) and one of the owners of the hockey team Calgary Flames, also joined Penn West’s board. The two have also invested millions of dollars in Penn West’s stock.
Shortly afterwards, Markin resigned due to unexplained reason, but I am inclined to believe it has nothing negative to do with Penn West since he still maintains his substantial investment in the firm. Some analysts (such as here) have indicated that Markin’s investments in Canadian Natural Resources while he was sitting on the board of Penn West could have created a ‘conflict of interest,’ which is why he resigned.
Canadian Natural Resources is a $36-billion market cap energy player with, as the name implies, a focus on Canada. Its weakness has been its negative free cash flow, disappointing income growth and little return on equity. However, the business has been expanding two of its major projects; the Horizon oil sands project and the Kirby In Situ Project.
The company is doing phase-wise development on the two projects and within the next four years, Canadian Natural Resources will be able to considerably increase its production, revenue and free cash flows. Its positive impact will start happening from as early as the current year. For instance, the Kirby south phase-one will give an additional sales boost of $1 billion in the current year. Therefore, I am bullish on Canadian Natural Resources.
Unlike most energy firms, Suncor, Rick George’s former employer, is mainly focused on the Canadian oil sands business, where it boasts of nearly 7 billion barrels of reserves and more than 23 billion barrels of contingent resources. Following some temporary shutdowns announced in the last week of June, Suncor is now operating at full capacity.
The company has decent fundamentals, solid cash flow, which could cause another dividend hike in the near future, and a growing revenue base. But like Canadian Natural Resources, it has a return on equity of just 6.1% and has struggled with falling profits. But due to its strengths, I believe that Suncor can be an attractive oil-sands play for the long run.
Penn West has a high quality-of-asset portfolio which, given the current stock price, I believe is undervalued. The investment by Rick George and Allan Markin also shows their vote of confidence in the firm’s assets.
Penn West is mainly about light oil and this is where it will do most of the development in 2013. By the end of June, Penn West had total land positions of 5.7 million net acres. The company holds more than 500,000 net acres at Carbonates and more than 100,000 net acres at Duvernay.
By the end of 2012, Penn West boasted of total proven reserves of 445 million barrels of oil equivalent, which is comprised of 55% light and medium oil and 10% heavy oil. It has 676 million barrels of oil equivalent of total proven and probable reserves, of which 52% are light and medium oil and 13% are heavy oil. The rest is either natural gas or natural gas liquids. The company will spend 30% of its capital expenditure on the Spearfish play, 15% on the Slave Point and 10% at Swan Hills region of the Carbonates play.

With a new management and a renewed focus toward efficiency, I am expecting significant improvements from Penn West in the coming quarters. The news of Markin’s exit caused its shares to drop by 4%, which I believe was an opportunity for a ‘buy.’
Its shares have since recovered rising by 20% and are currently trading at $12.47. But despite the rally, I believe that Penn West is still attractive because there is significant room for growth. The shares are still trading at a 32% discount to the company's book value. Moreover, following the dividend cut, it still generates an attractive yield of more than 5%. On the other hand, Canadian Natural Resources and Suncor give yields of 1.5% and 2.5%, respectively.
Investors should also note the extraordinary earnings multiples to which Penn West’s stock is trading. The price-to-earnings, or P/E, ratios based on the EPS generated in the last 12 months and the estimated EPS for the current fiscal year are shown in the table below. Penn West is trading more than 300 times its trailing and current full-year profit estimates, which is well above Canadian Natural Resources and Suncor’s multiples.
P/E trailing 12 months
P/E Current Full Yr Profit Estimates
I believe that this unusual number shows that the markets have very high expectations for Penn West and the stock will move higher. The overall trend is bullish, as articles from reputable publications, such as Barron’s and Bloomberg, have indicated that the stock could be worth $18 to $19 per share, which would represent an upside of 44% to 52% from the current price levels. 

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Sarfaraz Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy
Additional Disclosure: I, Sarfaraz A. Khan, have no position in any stocks mentioned and no plans to initiate any within the next 72 hours of this publication. I have no business relationship with any company mentioned in this article.