Penn West Energy Q4 2008 Update

All figures CAD$ unless noted:

  • Operating cash flow held up in the fourth quarter, dropping only 2% from Q3 to $602M. Funds flow from operations (FFO) fell 26% on a sequential basis to $490M, due to changes in working capital. The standardized distributable cash ratio (basically the ability to cover distributons from free cash flow) remains elevated at 1.52 for Q4, 1.34 for all of 2008. Any figure higher than 1 has negative implications.
  • The balance sheet remained somewhat static from Q3, with the only notable change being some gains due to hedges as the price of oil has dropped. Subsequent to the end of the quarter, Penn West announced capital raising of $238M from a bought-deal units offering and ~$190M in asset sales. The company plans to apply proceeds to reduction of debt, which stood at $3.9B at year-end.
  • The income statement divulges little on the state of Penn West’s operations. Netback margins remained high at 58% despite the drop in oil prices but this doesn’t quite square with the fact that operating income, once adjusted for unrealized hedging gains, showed a loss of $2M. Full cost accounting and the high level of depreciation charges probably factors into this disparity. PWE has roughly 25% of 2009 production hedged at favorable prices, which does not assure cash flow levels for the year.

In my previous post on Penn West, I speculated on possible scenarios for the company’s cash flow in 2009. Interestingly enough, the company did not provide any financial guidance for the year, other than to project capex at $600M – $825M. However, CEO William Andrews did clarify that Penn West could maintain its current $0.23 distribution with oil prices averaging US$45 for the year.


Working backwards (assumptions: midpoint capex of $712.5M, $0.23 distributions on 390M shares, 1.25 standardized distributable cash ratio & OCF = FFO), I get projected 2009 FFO of $1.4B.  This is very rough speculation and you could change some variables such as assuming management will try to live within cash flow or that FFO will exceed OCF like it does most years. The most important factor, though, is probably the oil price. Every US$10 change in oil prices equates to $190M in FFO.

I only engage in the previous exercise to get at a ballpark figure for this year’s expectations. I am relieved that my worst-case scenarios from last month are unlikely possibilities. Furthermore, the company shouldn’t have any liquidity problems as its credit line doesn’t come due until 2011.

Penn West also announced new reserve totals for 2008, which were unimpressive at 454MM BOE net proved reserves. However, the company did discuss three new prospects including the Shaunavon oil play in Saskatchewan and a new shale gas play near existing operations at Wildboy. These prospects sound promising but management has to deliver after Peace River (which is even more uneconomic in today’s conditions).

All in all, Penn West’s earnings update reassured me, despite the massive drop in its unit price. Its market price is probably wholly dependent on a recovery in energy prices but the company seems to be in position to weather sustained low prices through this year. In my eyes, management has lost some credibility over the last year or two but with the addition of Murray Nunns, hopefully they will be able to execute on their program of targeted capital spending, debt reduction and unitholder returns.

While I regret not selling my whole stake when I divested a third of it last year (let this be a final lesson — don’t let tax considerations get in the way of selling), it makes no sense to sell now. In fact, the stock could be undervalued at these levels but the uncertainty regarding the SIFT tax in 2011 precludes me from adding to the position. Perhaps management should clarify their intentions regarding Penn West’s trust status once tax loss shelters are exhausted.

Performance measurements:

  • Production -> 180,000 BOE per day before dispositions
  • capex: $600M – $825M
    • higher-end target only if oil prices recover > $50
    • execute on plans to drive costs lower for first half 2009
  • 2009 FFO: $1B – $1.7B
  • reduce $3.9B debt load
  • deliver results on new prospects:
    • Shaunavon
    • July Lake
    • Pembina

4 Responses to “Penn West Energy Q4 2008 Update”

  1. Bob Sharron Says:

    David,

    Thank you for your analysis on Penn West. I agree that Nunns is a great addition to the team.

    I also regret not unloading the 17,000 units that I still own. However, I don’t intend to sell at this low price either.

    I like the performance measurements you have listed as a guide.

    I do have a couple of questions:

    What in your opinion is the likelihood that PWE will convert
    to a corporate entity prior to or during 2011 thus ending its distribution and perhaps investors realizing a significant gain on the share price of the new entity?

    Secondly, assume they remain a Trust for awhile (beyond 2011), do you think that the unit value on the market will rebound (assuming oil is at 60-70 USD per barrel by 2010) to say mid 20s? I don’t think that we will ever see the market value of this Trust near the low 30′s that we saw last Summer.

    I’d really appreciate hearing your thoughts on market price and also when you think would be a good time to bail out.

  2. Davy Bui Says:

    Hi Bob,

    I can’t pretend to predict where I think the stock/unit price will go. If I could, we wouldn’t be having this conversation ;-) .

    I also can’t speak to the likelihood of PWE converting to a corporate structure — it’s hard to handicap what management might be thinking. They’ve stated that they have enough tax losses to offset taxes even after the SIFT hits. Combine that with the favorable tax treatment if they convert before 2013 and I’d say there’s a good chance PWE stays a trust until sometime before the conversion benefit expires.

    I will say, as an American shareholder, that I’d prefer to see them convert to a corporation once NOLs run out as I won’t get the same benefit that some Canadian holders will receive. But I can’t say how likely it is.

    I can’t speak to when a good time to bail out is (boy, I’m pretty useless!) but personally, I’d have to assess my cash position and also the market at any given time but generally, I’d be happy to breakeven on my remaining position (with distributions) at this point.

  3. bob jacobson Says:

    David Thanks for the analysis of PWE.
    You are doing professional work. Who are you?

  4. Davy Bui Says:

    Bob, I’m kind of at a loss on how to answer your question. My real name is Davy Bui; it’s not a pseudonym or anything, if that helps.

    If you have more specific questions, drop me a line at
    dvb@.@.@enlightened-american.com (sorry bout the funky @ signs to throw off spammers).

Leave a Reply

-->