Penn West Petroleum Ltd. has just become the biggest “show me” stock in Canada’s oil patch.
With a new chairman at the helm and a new chief executive officer coming aboard June 19, the Calgary-based company must now prove to the market that change is coming right down the line. Capital use has been inefficient, debt loads too high and the stock price undervalued given the class of assets on hand.
“The bold steps that Penn West’s board undertook are encouraging and would point toward a stock which is likely to appreciate,” says Greg Pardy, an analyst with RBC Dominion Securities Ltd. But the company “has further wood to chop in the coming months.” In a sign of good faith, on Thursday he nudged his target price up to $13 from $12, but maintained his “sector perform” rating until more details emerge.
Most investors so far have chosen to watch this recovery story from the sidelines. On Tuesday – shortly before chairman Rick George announced the appointment of Marathon Oil Corp. veteran David Roberts as Penn West’s next CEO – the shares traded at $11.14 on the Toronto Stock Exchange. They ended the session Thursday at $10.47. The 6-per-cent drop closely tracks the 48-per-cent dividend cut that Mr. George also announced, which will bring Penn West’s yield down to about 5 per cent from the 10 per cent offered today.
Penn West has been one of the least-loved energy stocks in the country, losing almost 60 per cent of its value over the past two years. The stock is down 4 per cent year-to-date. Analysts blame previous management for overpaying for assets and getting addicted to a high dividend payout ratio that the company could not afford. They like what they are hearing from the new leadership, but most aren’t willing to write the company a clean bill of health just yet.
“We will be looking for a huge step change in both where capital is spent as well as the efficiency of each dollar invested,” Mr. George said Tuesday in announcing Mr. Robert’s appointment. “We expect to start by reducing staffing levels by 10 per cent over the next few weeks.”
In addition, a special committee of the board is to look at selling assets, establishing joint ventures and making “other business combinations.” The review should be completed by year-end. “Penn West has many high-quality assets but the company has yet to unlock their complete value,” Mr. George said. At Penn West’s general meeting on Wednesday, the chairman made clear that the money to be saved on dividends will go toward reducing debt and not toward additional capital expenditures.
Michael Zuk of Stifel Nicolaus Canada estimates the dividend savings will amount to about $200-million a year, which could go a long way to improving the balance sheet. Long-term debt is close to $3-billion, giving Penn West a debt-to-equity ratio of about three to one. He is encouraged by the management changes but still sees Penn West as a $10 or $11 stock and rates it a hold.
One of the biggest variables will be prices in the oil and gas market through the year. Today’s soft conditions could make it harder for Penn West to fetch top dollar for any assets it sells.
Mr. Pardy says divestitures are essential for bringing debt levels down to industry norms. To do so, the company will need to sell at least $1.2-billion worth of properties, he says. He calculates that Penn West could get between $225-million and $270-million for its Duvernay shale formation and might also sell about half of its Cardium assets, worth an estimated $1.8-billion in total. But Mr. Pardy also points out that the company will need to spend about $1.2-billion just to maintain stable production levels.
Penn West has a long history of overpromising and underdelivering, says Allan Stepa at Desjardins Securities. This reputation will make it harder for the new management team to win over the Street, but early signs are promising, he notes in a report on Thursday.
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