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Penn West chief executive officer Murray NunnsTODD KOROL/Reuters

Penn West Petroleum's management team is doing its best to market an operational makeover, but for the moment the company's debt burden and its prospects for a dividend cut remain the focal points.

Sitting down with RBC Dominion Securities analyst Greg Pardy last week, Murray Nunns, Penn West's chief executive officer, stressed that he is focused on bringing new wells on-stream this year and added that the company's board of directors is now playing a much more active role after four executives left the company in November.

That's welcome news, but it doesn't resolve the burning questions about the company's dividend, which now yields just over 10 per cent. At the moment the company pays out $525-million to shareholders annually (before proceeds from the dividend reinvestment plan), or 56 per cent of expected 2013 cash flows. According to RBC's calculations that payout has to drop to $366-million this year and $318-million in 2014 -- amounting to a 40 per cent cut from current levels.

It all comes down to leverage. And at the end of 2012, net debt amounted to $2.9-billion, and Penn West simply can't afford to keep paying its dividend while also making hefty interest payments. To get its debt down to 1.5 times to 2 times earnings before interest, taxes, depreciation and amortization, RBC calculates that Penn West would have to reduce the debt burden to between $1.5-billion and $2-billion.

The good news is that the company got the message, and is aware that it needs to slash the debt to prove to investors that it's on the right track. From June to December last year Penn West sold $1.35-billion worth of assets that went toward paying down its credit facility.

But management won't acknowledge that the dividend could be in trouble. On the last quarterly conference call Mr. Nunns said "we believe the dividend to be an appropriate component of our business model, as it provides a balance of immediate return as we prove the full resource potential and value of this company."

He then added: "We have an asset base that is unlike a lot of our peers. We have a vast array of light oil assets, which provide strong cash flow, and a resource base with significant upside, which demonstrates good ability to add economic reserves." In other words, trust us – our resources will protect the dividend.

This means one of two things. Either the company thinks it can keep selling assets to pay down its debt quickly, or that new production will result in stronger cash flows. Both have merit, but prices for roughly two-thirds of Penn West's 2013 oil production and 40 per cent of its natural gas production are hedged, so the company doesn't have a lot of leeway for upside surprises.

Mr. Pardy does give the company credit, with a caveat. "There is no question that Penn West is well endowed with a resource rich portfolio which includes the Cardium, Viking, Carbonates and Spearfish. Nonetheless, reducing its financial leverage and right sizing its dividend are both important elements that will ultimately determine its ability to bridge the gap between its market price and its underlying net asset value."

(Tim Kiladze is a Globe and Mail Reporter.)

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