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Are Shares In These 2 Oil Companies Set to Surge?

The last decade has been a tumultuous time for Canada’s largest energy producers.

In 2004, natural gas hit a record high because of damage done to U.S. Gulf Coast energy infrastructure by Hurricane Katrina. In 2008, we saw oil prices surge to more than U.S. $140 per barrel before crashing to under $40 just a year later. The last decade also saw the rise of Canada’s oil sands into one of the jewels of the world’s energy supply, as higher prices and new technologies made the oil sands economically feasible.

For the most part, it’s been a profitable decade for Canada’s largest energy producers. Most energy stocks are down from their 2008 highs, but if you look at a total return over the decade, most have experienced slow and steady share price appreciation, as well as paying significant dividends to shareholders.

Unfortunately for some investors, there have been a couple of notable exceptions — Penn West Petroleum (TSX: PWT)(NYSE: PWE) and Talisman (TSX: TLM)(NYSE: TLM). Talisman has just returned 2.5% a year over the last decade, while Penn West has fallen some 65% since its conversion from an income trust in 2005. Investors in these two companies haven’t had a good decade, to say the least.

Fortunately for investors of these two companies, the pain is almost over. Here’s why I think both are set to outperform going forward.

Penn West

Penn West struggled under a large debt load, weak management, and non-producing assets. During 2012 and 2013, the falling price of natural gas hurt the company as well, since the company is a major natural gas producer. All these factors lead to a dividend cut about a year ago.

The company brought in new management, which has been doing a nice job. Penn West sold a bunch of non-core assets, choosing to focus on areas with the strongest fundamentals. This not only helped shore up the balance sheet, but also improved the company’s operating ratios, since it was no longer weighed down by these non-producing assets.

The company managed to sell those assets for more than intended, and used the vast majority of the proceeds to finally get its debt under control. The balance sheet now sports the best debt-to-equity ratio it’s seen in years, and the decrease in interest costs has helped improve the bottom line.

Penn West is currently trading at a 30% discount to book value, and is now comfortably earning enough to cover capital improvements, interest on its debt, and the 5.6% dividend. It also stands to benefit significantly when the Northern Gateway pipeline finally gets completed, which will open up the markets of Asia and the much higher energy prices those countries are willing to pay.

Talisman

Talisman is truly a worldwide energy company, with operations in North America, Columbia, Australia,southeast Asia, the Middle East, Africa, Norway, and the U.K. It has operations in some of the largest energy areas in the world.

The company had poor results in 2013, losing more than $1 billion on asset write downs. The company spent 2013 shedding itself of non-core assets — much like Penn West — raising more than $2 billion in the process. Talisman intends to sell another $2 billion in assets during 2014.

All this capital is going to be used to pay down debt and fund growth in both North America and Asia Pacific, where the company is going to focus its production. It plans to grow total output by 14-19% in these two key areas, at the same time as growing its gross margin per barrel of oil 6-11%. All this should translate to a 5% improvement in cash flow, to just over $2 per share.

At just over $11, Talisman is only trading at less than six times cash flow, with potential to improve it. This is a discount to its peers, with better growth potential. The company simply doesn’t get any respect because of its recent operational issues. Once the company works through the current issues and the market starts to warm up to the name again, look for nice returns.

Talisman also has an interesting wild card. Billionaire Carl Ichan owns a sizable piece of the company, and is said to be pushing for a sale. There are rumors that the company already turned down a $17 billion buyout offer, which is about a 50% premium from today’s share price. Patient investors could see another company swoop in and give them a nice takeout premium.

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Fool contributor Nelson Smith has no position in any stock mentioned in this article. 

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