Penn West: No Reason To Get Too Worried

This report lays out some of the reasons I like and have bought this stock. It does not constitute personalized financial advice. Please do your own due diligence or hire a financial advisor (if you're so inclined) before making any investment decisions. DISCLOSURE: Author is long this stock.

Penn West Energy Trust reported 2nd quarter results a week and a half ago. This is one of my earlier research reports so I don't have a set of performance measurement standards laid out for them but will formulate them for this update.

While total overall production increased, from a unitholder's perspective, the Petrofund transaction was slightly dilutive (~6%) in terms of production.
Long-term debt is up 44% to C$1.8B and total liabilities up 27% to C$3.6B. Debt-to-Equity and Total-Liability-to-Equity ratios are up but still safe at 0.39 & 0.77 respectively. Goodwill/intangibles comprise only 7.8% of total assets.
Top-line revenues increased 39.3% YOY but operating expenses increased 77% largely as a result of the Petrofund merger. Operating income fell 9.5% YOY and Net income was a loss of C$185.2M due to a one-time tax charge of C$326M due to the royalty trust tax change. Excluding this, income was C$140M but still down YOY.
Operating cash flow results were positive YOY, even taking into account dilution. As the tax hit was a non-cash charge, OCF was up 45%, FCF (excluding acquisitions) up 68%. Even on a per unit (share) basis, OCF and FCF were up 0.4% and 16.5% respectively.
Management reduced guidance by $100M on the top end of cash flow as well as cutting 1,000 boe/day from the production range.

A fire at their Wildboy gas plant is responsible for the lowered guidance. Company expects to fully resolve this by October 2007.
They are also late on some tie-in work at the Peace Rivers property (3 months according to CEO Andrews). Once completed, the company will be able to cut transportation costs, save 1 mcfe/day in gas and ramp up production.

So what to make of it? Not much really. While the net loss for the quarter does get one's attention, it is a result of the implementation of the Canroy tax change, which was passed into law this past quarter -- in other words, not new information. On a cash basis, the company seems to be floating along. Netback per barrel was slightly lower due to hedging effects and they were hurt by the strong Canadian dollar.

While the company has little control over tax law, oil prices and exchange rates, they do have control over operations. In this respect, results were slightly disappointing. Penn West's Peace River Sands prospect has huge potential (6.8B barrels oil in place -- company estimates anywere from 300M to 1.3B bbls recoverable by rough estimates). However, oil sand projects are subject to significant operational challenges and the Wildboy setback and tie-in delay does not inspire confidence. But that's the nature of the business so I don't want to make too much of it. Even Ed Murray and Canadian Natural Resources are struggling to bring their oil sands project online. Just something to keep an eye on.

Going forward, the company seems intent on maintaining their distribution payout (currently yielding ~11%). Even though they booked the tax charge now, management estimates having enough NOL credits to offset the new tax until 2014. By my calculations, they have a little over C$1.1B in short-term float-rate credit, which isn't ideal. However, I do like their recent placement of US$475 fixed notes. That should act as a de-facto hedge against the weakening dollar.

The company has stated repeatedly that they can increase equity by C$9B without triggering the tax early. I'd anticipate they will seek to take advantage of this but hopefully, in a manner that will increase unitholder value, not dilute it.

We got essentially no new developments on the Pembina CO2 enhanged-recover project. Still working on securing CO2 supplies. 2 wells are flowing at encouraging rates and the company is starting the 2nd phase in 3Q 2007 with first production in early 2008.

The company does expect to have its Peace River resource numbers independently verified by the end of September. It will take a number of years to formulate a development plan and book reserves.

Their Prime Well Program is coming online as their farmed-out lands are now moving into production. Management expects results to increase moving forward.

Hit guidance: (C$1.3B-1.4B cash flow, 129,000-132,000 boe/d production)
Complete Peace River well tie-ins. We should see lower transportation costs and increased production from those wells.
Bring Wildboy back to full production by 10/2007.
Restructure debt as opportunities present themselves
Maintain or increase distribution, at least until 2011.
Develop the Pembina CO2 project on-schedule (phase 2 --> 1Q 2008)
Verify Peace River resource numbers and complete oil production facility.
Prime Well Program add more production.

DISCLOSURE: Author is long this stock

The Enlightened American

Penn West: No Reason To Get Too Worried