Why Penn West Petroleum Ltd. Suddenly Became a Great Buy

Why undervalued Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) suddenly became much more attractive.

The Motley Fool

Normally, investors would be better served not checking their stocks on a daily basis.

Although most pundits would never admit it, most of the time we don’t really know why markets go up or down. We get responses like “investors are optimistic” and “investors are taking profit,” which really don’t mean anything at all. They’re silly, but television networks, newspapers, and other forms of media have a lot of time they need to fill.

So they talk about a lot of stuff that isn’t useful at all to a long-term investor. That’s why you should ignore most of it.

Every now and again, though, news will come out that affects a stock in a material way. Usually, the stock will shoot up (or down) as investors digest the information. These are the days that investors want to pay attention to their individual stocks. These are the days that matter.

Yesterday, Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE) had one of those days. Just what exactly made it so important? Because it confirmed what we already know. Or at least what we wanted to know.

First, the bad news. In late July, the company’s new CFO found some accounting irregularities when going over the books. Essentially, previous management had listed certain operating expenses under capital expenses, which boosted operating cash flow. These irregularities had been going on for at least two years.

To management’s credit, they did the right thing. They immediately informed investors about the problem, and the stock took it on the chin. Shares fell approximately 20% on the news, and this was after years of underperforming its peers. It was the last straw for many investors, who took the opportunity to rid themselves of the name.

Finally, the company received some good news yesterday. The results of the accounting probe are in, and it didn’t turn out to be nearly as bad as first anticipated. The company restated $367 million of capital expenses as operating expenses dating back to 2012, and earnings over the last two years, but that was it. No other significant issues were found.

Additionally, it restated 2014 operating guidance, kept its dividend intact,  and released second-quarter numbers, which beat analysts’ expectations. All told, it was a terrific day, and the stock responded accordingly, shooting up nearly 8%.

Here’s why it’s more important than just clearing up the accounting scandal: Management had the chance to use it as an opportunity to clean the slate, so to speak. If there were any changes to be made to the company’s outlook, dividend policy, or anything else important, this was the prime time to do it. Sure, the stock would have gotten punished, but not nearly as badly as if it brought out bad news a few months from now.

Meaning, management is confident about the future.

Investors should be, too. New management has barely been on the job for a year and is already starting to make a difference. It also trades at nearly half of book value, has plenty of cash still on the balance sheet, and has indicated that its plan to shed non-core assets is right on track.

There’s another potential catalyst to the upside as well. The company is facing several class action lawsuits regarding the accounting scandal. If these get cleared up with a minimal expense, look for shares to jump again, as the last of the accounting woes get washed away.

I’m not usually one to get excited about a stock with an accounting probe, but Penn West is a special situation. Investors should be pretty excited about this new management team. Now that the issues are mostly in the rearview mirror, look for the stock to move higher.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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