One-time deeply troubled upstream oil producer Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) has pulled off a miracle and come back from the dead. The company appeared to be destined for failure as the protracted slump in crude took it to the edge of bankruptcy; it laboured under a mountain of debt that forced it to accelerate asset sales and renegotiate its financial covenants.
With its financial position rapidly deteriorating because of sharply weak oil prices and declining production, there were signs that that it would be unable to continue as a going concern after the end of the first half of 2016.
Now, however, there are signs that not only will Penn West survive the current harsh operating environment, but that it has finally turned the corner and is capable of unlocking value for investors.
Now what?
Firstly, Penn West’s divestments have exceeded expectations with recently completed sales guaranteeing its survival.
The game-changing disposition for Penn West was the closing of the sale of all of its Saskatchewan assets for $975 million–more than double what analysts were expecting. These included its Dodsland Viking light-crude assets as well as its medium and heavy oil properties in western Saskatchewan.
Even after this significant transaction, Penn West surprised the market by announcing an additional sale of non-core assets in Alberta for $140 million, which saw it generate total proceeds of $1.3 billion for 2016. This resulted in it being able to reduce its debt to $566 million, or almost a quarter of where it was at the end of 2015.
As a result, Penn West is now in compliance with its financial covenants and there is no risk of it ceasing to be a going concern. It has even continued with its asset-divestment program, making agreements in the second quarter to sell an additional $75 million of assets, which will reduce its debt to $491 million on completion, further strengthening its balance sheet.
Secondly, oil production has exceeded expectations.
For the second quarter Penn West reported average production of 63,568 barrels daily, which was almost 12% higher than the top end of its 2016 guidance. This can be attributed to better-than-expected results from its exploration program coupled with fewer wells being shut in than originally planned.
The higher-than-expected production comes after eight straight quarters where production declined and is an extremely pleasing outcome, especially with oil now having recovered to above US$40 barrel. It also highlights the quality of Penn West’s core Cardium and Alberta Viking oil properties and the potential that exists to further expand production as those assets are developed.
Finally, the considerable reduction in debt and additional financial flexibility this has given Penn West has allowed it almost double the funding for its exploration and development budget.
This is a particularly important outcome because not only will Penn West be able to replace the production lost through natural decline rates, but it will also be able to increase both of its oil output and reserves, unlocking value for investors. Over time this will boost Penn West’s oil output and cash flow, increasing its financial flexibility and giving its bottom line a healthy bump.
So what?
It has been a tough journey for Penn West. Many, including its own management, were fearful that it wouldn’t survive past 2016. Nonetheless, the company has pulled off a miracle, obtaining more than double what many analysts believed it would for its Saskatchewan properties and using those funds to reduce its debt to manageable levels.
As a result, Penn West has rallied 65% for the year to date, and with a stronger balance sheet as well as the ability to grow production, there are signs that that it can only appreciate further in value.
