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Should You Take a Flyer on Unloved Penn West Petroleum Ltd.?

It’s been a rocky ride for Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE) shareholders.

Shares have been headed consistently lower for the better part of four years. Results have been weak, management made some costly blunders before being largely replaced, and in late 2013, the company halved its quarterly dividend.

And then, more bad news hit. In July, management announced that it was delaying filing quarterly results because accounting irregularities had been found. Essentially, the company had been claiming operating expenses as capital expenses. This propped up operating cash flow, since there were fewer operating expenses. And higher operating cash flow is obviously a good thing for shares, since it’s one of the key metrics for determining profitability in the oil patch.

Not only have shares slid 20% since the news, but the company has had to negotiate with its creditors about it, since delaying earnings filings technically puts it in default of its debt. And just last week, there was a class-action lawsuit filed against the company, from jilted investors.

Yikes. This is bad. But is it also a buying opportunity? Let’s look at the reasons why investors should shrug off these struggles and take a look at the stock.

1. It’s cheap

Many successful investors — including billionaire Warren Buffett — have the foresight to buy high quality companies at beaten-up prices, leading to great returns. Does Penn West qualify?

On the surface, it might be the cheapest oil company in Canada. Shares trade at approximately half book value, and less than four times cash flow. Obviously there’s some doubt behind all the company’s numbers, but that’s easily reflected in the share price.

Other observers have cast doubt onto the company’s assets, claiming that they’re not great because its netback isn’t nearly as high as its rivals’. Perhaps that’s true, but most oil companies trade at much higher multiples of book value. Are Penn West’s assets really worth a third as much as Husky Energy Inc’s (TSX: HSE), which trade at 1.5 times book value? I’d say there’s more value there than that.

2. Management leading the way

Over the last couple years, Penn West’s management team has been almost entirely replaced, ushering in a new era of accountability.

CEO David Roberts has 30 years worth of experience in the industry, and is generally credited with leading Marathon Oil’s turnaround. And new CFO David Dyck has only been on the job since May, but he’s obviously a man of integrity. It would have been much easier to sweep this accounting issue under the rug, especially since it was the previous management team’s fault. Instead, management is doing the right thing, even though the short-term pain from that decision is difficult.

I have confidence that Roberts and Dyck can turn the company around. They’re the kind of people shareholders should want in charge.

But should investors buy now?

I’m relatively sure the company will recover from this latest setback, and investors will probably look back on this five years from now and lament missing a great entry point.

There’s just one problem. Accounting scandals tend to uncover more bad things.

In the accounting world, it’s called the cockroach theory. Not only is there risk that Penn West’s accounting probe uncovers some nasty things hidden in the books, but there will also be the tendency to flush out all the potential bad news when the results come in. Ultimately, that could send the stock lower, or management could even decide to cut the dividend, which currently yields 7.2%.

Instead of buying now, I’d be patient. Wait until at least the accounting probe has ended, and maybe even a little longer. I don’t think all the bad news is gone from the stock, meaning patient investors could easily pick up shares at a lower price. There’s no need to rush into this.

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Fool contributor Nelson Smith has no position in any stocks mentioned.

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