Penn West Petroleum Ltd.: Avoid This Value Trap

Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) may be trading at its lowest point since 1997, but it is fast becoming a value trap.

| More on:
The Motley Fool

It’s a tough time being an investor in Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE), with 70% wiped off its share price over the last decade and now trading at its lowest point since late 1997.

This has some analysts claiming that the company now represents a long-term value investment play. But even after the relatively positive outcome from the accounting probe, Penn West is still grappling with a raft of unresolved issues, weaker industry fundamentals, and a mountain of debt. I believe all of these add up to making Penn West a value trap for investors to avoid.

Industry fundamentals continue to weaken

Falling crude prices continue to have an adverse impact on oil companies, with WTI trading at well below $90 per barrel and Brent tumbling to its lowest point since 2012. But the pain for the industry doesn’t stop there. I expect crude prices to weaken further because of growing global supply and declining demand.

Between now and 2020, U.S. crude production is expected to grow on average by 4% annually, while the Saudis are aggressively cutting crude prices to boost market share.

Meanwhile, China’s economy continues to stumble, with declining industrial activity and a softer housing sector causing demand for crude from the world’s largest net importer to plunge. The stagnating economies of the eurozone and the region facing the threat of a triple-dip recession have caused demand for oil to wane, and there appears to be no end in sight to the region’s woes.

These factors will all have a significant impact on Penn West by reducing operating margins and negatively impacting cash flow, raising concerns over its profitability and sustainability of its dividend.

Operational performance remains poor

In 2013, Penn West embarked on a project to turn its business around by boosting margins, preserving capital, and reducing leverage. There are signs some progress has been made, but it is still struggling with a range of internal problems that are being exacerbated by softer industry fundamentals.

Key is declining production, primarily caused by asset sales, which saw second-quarter 2014 production down 24% compared to the same quarter in 2013. This leaves Penn West unable to fill the shortfall in revenue caused by softer crude prices with increased production.

It is also struggling to boost higher-margin light oil production, with lower-margin heavy oil and natural gas still making up almost half of Penn West’s production mix. This is reflected in its poor second-quarter netback per barrel of $39.37, which despite being a 39% increase year over year, is still significantly lower than many of its peers. For the same period, Crescent Point Energy Corp. (TSXS: CPG)(NYSE: CPG) reported a netback of $54.75, while Lightstream Resources Ltd.’s (TSX: LTS) was $57.49 per barrel.

This leaves a narrow margin to absorb softer crude prices before funds flows are negatively impacted, which would affect Penn West’s ability to meet financial obligations, including dividend payments.

Currently, dividend payments combined with production-sustaining capital expenditure and debt repayments exceed funds flow, with Penn West meeting the shortfall using the proceeds from asset sales. Obviously, this can’t continue and the only option for Penn West would be to cut its dividend and reduce debt repayments and capital expenditures.

Weak balance sheet

Another concern is that despite Penn West having completed a series of asset sales, the proceeds of which were used to pay down debt, it remains heavily leveraged. At the send of the second quarter, it still had a mountain of debt totalling $2.2 billion, which is almost three times cash flow.

I also expect to Penn West’s net asset value to decline significantly in the immediate future, as the company is set to write down the $1.9 billion in goodwill held on its balance sheet. This figure is predicated on inflated asset values from earlier acquisitions and makes up 16% of total assets.

Penn West continues to struggle with declining production, low margins, a sizable debt, and inflated asset values. This creates considerable concerns regarding the sustainability of its dividend and the profitability of its operations. With the looming threat of asset writedowns, its share price can only fall further.

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.

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

More on Energy Stocks

bulb idea thinking
Energy Stocks

This Stock Is Miles Ahead of Its Industry: Is It a Buy Now?

This stock has proven to be well worth the investment, especially at a time with increasing demand for clean energy…

Read more »

Oil pumps against sunset
Energy Stocks

Is Suncor Energy Stock a Buy in 2024? 

Let's dive into whether Suncor Energy (TSX:SU) is a stock that's worth buying in this current environment or if investors…

Read more »

oil tank at night
Energy Stocks

Is CNQ a Buy Before its Upcoming Stock Split?

CNQ stock is a high-dividend TSX energy giant with a growing dividend yield. Is CNQ stock a good buy right…

Read more »

Solar panels and windmills
Energy Stocks

How Brookfield Renewable Stock Gained 40% in a Month

Brookfield Renewable stock (TSX:BEP.UN) surged in share price from a landmark deal and strong earnings, leading to a 40% jump.

Read more »

analyze data
Energy Stocks

Check Out This Soaring Stock, up 469% in 5 Years, With More Gains Likely to Come

If there is perhaps one growth stock that's just taken over in the last five years, it's this monster of…

Read more »

gas station, car, and 24-hour store
Energy Stocks

Is it Too Late to Buy Suncor Stock?

Suncor Energy stock has rallied big in the last year, but expect it to move higher as efficiencies keep rolling…

Read more »

Oil pipes in an oil field
Energy Stocks

TSX Energy Sector: Best Stocks to Buy in May 2024

Energy stocks like Suncor are generating massive amounts of cash flows and paying out significant dividends.

Read more »

Man holding magnifying glass over a document
Energy Stocks

Bargain Hunters: Is it Too Late to Buy Enbridge Stock?

Enbridge is up about 10% in recent weeks. Are more gains on the way?

Read more »