The arrival of Murray Nunns has definitely invigorated Penn West on the operational side. F&D costs are down, reserves are being defined and exploration prospects are being put in clear focus, with three promising plays being primed for horizontal drilling. The company reduced debt by over $1B as well so Nunns has undoubtedly made positive changes at the company. PWE has also made a key strategic shift to more oily/liquids production in a very weak gas market, with 69% of proved reserves in the oil category.
Unfortunately, Penn West is still running a negative sustainable free cash flow ratio, with capital expenditures + distributions overrunning the cash flow generated. This may be a moot situation as PWE plans on converting to a corporation in the coming months and as a result, will be lowering their payouts to execute more of a growth strategy needed to sustain a corporate structure.
So what’s the company worth? With roughly 500MMBOE equivalent in proved reserves, I would peg fair value at ~$25 per unit but a few factors complicate this assessment. Management asserts new horizontal drilling techniques will allow them to recover substantially more oil and claim more reserves. In the past, I would be skeptical but with Nunns onboard, I am inclined to believe them. However, even with new reserves, there is still a risk that PWE issues more dilutive equity before converting to the corporate structure which would lower fair value per share.
With all these factors in consideration, I am using $25 as a fair value target, with the company’s prospects, new focus and oiliness offsetting further dilution. While this number is lower than my initial buy point, the trust’s high payout levels over the past three years means my stake, including distributions, is a net winner in my actual portfolio.
As always, YMMV.