It’s been a tough time being a Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE) shareholder.
Over the last decade, shares have lost an astonishing 83% of their value. That was partially subsidized by the company’s generous dividend, but it’s still a terrible performance — especially considering some of the gains from other companies in the energy patch, like Suncor Energy Inc., which nearly doubled during the same time period.
All this negativity culminated back in July, when the company announced its new CFO had discovered accounting irregularities. Essentially, the company was taking operating expenses and recording them as capital expenses, which helped operating earnings appear more robust than they actually were. As a result of the scandal, the stock once again plunged, dipping below $8 per share.
Just a couple of weeks ago, the company announced the result of the probe it launched into its accounting practices. Not only did it find nothing else wrong with the way it did its books, but management also reiterated its outlook for the rest of 2014. In fact, results were even better than it and analysts expected. The stock rallied on the news.
But the rally was short-lived, and the stock has settled back down at close to the $7 level, taking the overall market weakness on the chin. In a declining market, would you own a weak player like Penn West or a stronger competitor?
This raises the question: Should investors ever get back into Penn West?
Over the short term, the answer is a resounding no. If the market continues to be weak, investors will continue to move out of weak names and into stronger ones. And if weakness stretches into December, spurned investors could look at taking a tax loss and washing their hands of the company. This could push shares down even further.
Plus, analysts are speculating that the company could write off some of its assets. Penn West’s book value is approximately double its share price, a huge discount compared to its peers. The market seems to be pricing in write-offs. But if the company were planning on writing off assets, why wouldn’t management do it when restating numbers after the accounting scandal? That was the perfect opportunity.
As a short-term investment, Penn West doesn’t appear to be a good bet. But as a long-term one, the company is beginning to look very interesting.
The biggest factor in its favor is a stellar management. The new CFO was barely on the job for a quarter before he discovered accounting irregularities. Instead of sweeping them under the rug — which would have been the easy solution — management made the right decision and fixed the problem. And, frankly, the differences between capital and operating expenses can be pretty small sometimes. Perhaps all these problems were caused by nothing more than interpretations of accounting rules.
The company is also making progress on its asset sales and debt repayment plans. Long-term debt was $2.9 billion a year ago, and today it stands at just $1.9 billion. That’s still a lot for a company with a market cap of about $3.5 billion, but at least it’s going in the right direction. And further asset sales should help get the number more under control.
Penn West has chosen to focus its attention on three main areas — Cardium, Viking, and Slave Point. These are all good producing areas, yielding mostly light oil. Approximately 40% of the company’s 625 million barrels of reserves are located in these areas. Penn West has valued all of its reserves at $8.9 billion. Meaning, the market is valuing the entire company at the same value as its three main areas.
That’s the crux of buying Penn West at current levels. Sure, it’s got too much debt, and there are other operational issues. But investors are buying some nice assets at a cheap price. Yes, there are doubts about the value of its non-core assets, but at today’s depressed levels, investors are essentially getting them for free.
This could be a great long-term opportunity for investors willing to look past all the short-term noise. It’s that simple.
