|Shares Out. (in M):||467||P/E||0.0x||0.0x|
|Market Cap (in $M):||8,591||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||2,815||EBIT||0||0|
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Proved + Probable: 660mm boe
Overall, I believe Penn West is an over-capitalized E&P asset that has as deep and rich an inventory of light oil and natural gas assets as any of its relative size. There are three natural arbitrages here:
3 years ago Penn West was a high dividend paying income trust in Canada whose assets didn’t bear reinvestment because they were high cost and so the corporate structure was designed to keep production flat and pay out high levels of dividends for income-oriented investors. With the technological renaissance related to horizontal drilling and hydraulic fracturing, the 7-8mm acres that Penn West owns in the western sedimentary basin in Canada have serendipitously turned into huge optionality that we are seeing the first hints of.
I believe we are in the very early innings of appraising and developing one of North America’s most under-appreciated asset bases. The company has begun a transformation that will lead to significantly higher earnings power over time via higher production growth rates, advantaged royalty costs, higher operating margins on product produced, tax advantages based on structural issues with the corporate status change, and a reallocation/redeployment of capital to high return drilling opportunities.
In the hands of a world class operator with a strong and diversified capital base, I believe this transformation will happen more quickly, more efficiently, less costly, and with less growing pain which is why I think this is a M&A target and Sinopec’s recent acquisition of Daylight clearly puts Canadian assets in play.
Penn West has a strong base of conventional oil and natural gas production (19%-20% decline rate) that provides a strong source of cash flow that can provide over $1.5bln of operating cash flow @ $80 oil to drill a deep, valuable asset base that has been revitalized by new drilling and completion techniques. What was a high cost, boring asset base has now turned into a wealth of opportunity spanning from primary drilling in mutli-zone fields with significant ultimate EOR potential given the nature of the rocks on over 7mm acres in Western Canada.
Acreage math works out to less than $2,000 per acre for the enterprise without stripping out their 170k boe/d of production.
Unlike most US E&Ps who spend in excess of cash, this company generates free cash and pays a 6.5% dividend with that free cash. This is the first company I've looked at where I would urge them to cut the dividend and accelerate investment. Here is where I believe a very simply arbitrage can be head.
The last thing buyers of North American assets need is a $500mm dividend. And while this dividend was suitable for Penn West 3 years ago, it simply no longer is. This transition of moving away from the dividend will be a very difficult process in the public markets. As such, I believe this company is a sitting duck. There are two ways to look at this:
1. What is this worth on a no growth trajectory? In other words, if this were treated like a big major oil company or a dividend payer with flat production, what would the appropriate yield be? (Note that this would be yield to equity.) The following is with oil around $85-90. The $900mm of capex is what you’d need to keep flat. Arguably this comes down over time as the conventional decline rate plateaus.
|Flat Production Case|
|Cash from Ops||1,700|
|Implied Value at 4% yield||20,000|
|Implied Value at 5% yield||16,000|
|Implied Value at 6% yield||13,333|
|Cash from Ops||1,700||2,000||2,200|
|2011 Production Exit||168,000||175,155||187,154|
|Gross Production Adds||38,235||46,154||54,839|
|2011 Production Exit||175,155||187,154||205,498|
|Exit to Exit Growth||4.3%||6.9%||9.8%|
|Invest Excess Capital Case|
|2011 Est||2012 Est||2013 Est||2014 Est||2014 Est|
|Cash from Ops||1,700||2,100||2,500||2,900||3,300|
|Prior year Production Exit||168,000||175,155||194,846||225,870||262,054|
|Gross Production Adds||38,235||53,846||70,968||84,746||89,286|
|2011 Production Exit||175,155||194,846||225,870||262,054||294,998|
|Exit to Exit Growth||4.3%||11.2%||15.9%||16.0%||12.6%|
|Cash from Ops||1,700||2,100||2,500||2,900||3,300|
Assuming $90/$5 after 2011, in this case, you phase out the dividend over 3 years and drive the capex higher as you eat into the inventory of wells. By 2014, the company will again be generating excess free cash but you have production (before royalties) of close to 260,000 boe/d with 75% from liquids.
A full blown NAV of the company get you easily to $30+ share price and based on 2012 production exit of 185k boe/d @ $120k per flowing boe, I think it's worth $35 (I use 85% NRI on the 185k boe/d production rate to get that number).
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