It’s a tough time to be investing in the energy sector.
With the exception of the largest names in the sector, the carnage has been unbelievable. Many solid producers with good balance sheets are down 50% over the last 52 weeks, and are down 60%, 70%, even 80% from prices reached in the summer when the price of crude flirted with $110 per barrel. That has to be painful for long-term investors.
Many value investors are taking a look at beaten-up energy names, trying to find the best investment. There are dozens of choices, but my money is on Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE). In fact, from today’s level, I think there’s easily potential for this stock to double — and then some. It’ll require a few things to go right, but the possibility is there.
Unlike most other energy producers, Penn West was actually a good value before the price of oil collapsed.
But considering all of its problems, the company deserved to be cheap. The previous management team suffered from shiny ball syndrome, always distracted by a new acquisition while executing poorly on the operational side. And since the company was also a big natural gas producer, the decline in that commodity didn’t help either.
And then, right when the board had managed to get rid of most of the previous management team, the new CFO dropped a bombshell. For 2012 and 2013, the company had been classifying certain operating costs as capital costs, which boosted cash flow metrics. The new CEO immediately launched a full investigation and fixed the problem, but the damage was done. Many long-suffering investors bailed on the name.
Because of all this bad news, the company was trading at below book value before the price of oil tanked. At least management managed to sell off more than $1 billion worth of assets that were previously acquired by the last management team, applying the proceeds to the company’s bloated debt load.
The result? Penn West entered this new energy bear market in pretty good shape. Most of the recovery heavy lifting is done, now all it needs to do is wait for the price of crude to recover.
A double whammy
This unique set of circumstances creates a great opportunity for Penn West’s shares.
If crude continues to head higher, the company’s shares will be rewarded. Look at the trading action on the stock since the end of January if you need any further confirmation. Oil is up some 15% from its bottom, yet shares of Penn West are up more than 50%. If you’re a long-term bull on the price of oil, it’s obvious you want to own this stock.
As an investment spanning several years, the company is even more compelling. Not only will shares benefit from crude going up, but it is also likely to continue its turnaround. It can start to dispose of non-core assets again, and management’s new focus on three main areas looks to be a winning strategy. The company should even be able to attract some top talent at a cheap price.
Between the potential for crude to rally and the company’s turnaround, there are plenty of reasons to be bullish.
Still a risky bet
Keep in mind that Penn West cannot execute its turnaround plan if oil stays at today’s levels. It just isn’t profitable enough at $50 crude.
While the decline in the Canadian dollar has helped somewhat, Penn West really needs oil to be between $60 and $65 for it to be able to afford its capital expenditures, let alone be profitable. Crude really needs to get back above $70 per barrel for Penn West to even consider paying a decent dividend again.
Buying Penn West at these levels isn’t the same as buying one of the big boys in the sector. It is very much an investment based on the price of crude. As goes crude, so goes Penn West.
As a core position, I can’t recommend Penn West. But as a small, speculative part of your portfolio? I think it’s worthy of that sort of investment. No matter what happens, chances are it won’t be boring.
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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 Nelson Smith owns shares of PENN WEST PETROLEUM LTD..