PBN Analysis - Part 2 ...so I am at the airport - waiting to catch a flight with some time on my hands - so another blog from me...
PBN is a patience game for sure - but - there are some pitfalls that I do believe management is acutely aware of - and will address accordingly in due time.
Debt Levels
1) Management knows - at some point - they will likely have to sell some of thier non-core assets to bring debt levels down. It is likely the only meaningful way to deleverage the balance sheet.
a) Cutting the dividend is highly unlikely in my opinion and would be irrational. Given that the cash payout is in the mid teens - cutting the dividend would hardly would put a dent in their net debt - it always surprizes me how analysts talk about the dividend yield at 11% not being sustainable - its such a misguided argument to make without doing a bit more digging. A high yield suggests to me that the dividend is unsustainable - or the company is grossly undervalued. If you look at thier cash payout (last check around 14%) - and annual cashflow near $600M in 2012 - a payout after DRIP of approx $100M (assuming 50% DRIP participation) is pocket change. If the stock price hit somewhere around $16 or closer to book value - this would be a 6% dividend stock - in line with other O&G - so when smart people clamour to have PBN cut thier dividend - do your homework - its such a foolish argument to me- and not likely to happen to bring down debt. This is why I believe strongly the dividend is sustainable and is a key focus for management. They would not risk hitting the current stock price (at a huge cost to stock price) for a small impact on debt (marginal gain).
b) They can again cut CAPEX for 2014 - but to my earlier email - as prices and differentials improve - they will have more incentive to increase CAPEX in 2014 to capitalize on improved conditions which I believe was thier game plan all along and indirectly communicated when 2013 CAPEX was announced (ie. economy, WTI prices, WTI differentials, etc). CIBC research is betting total 2013 cashflow at $619M....based on my model - that amount is underestimated by almost $100M (per my earlier post)....a conservative plausible case given current price trends puts them at $716M if not higher for 2013 (ive modeled scenarios that put PBN at $750M to $800M cashflows if production, prices, differentials, netbacks, cost containment, etc - everything goes in thier favour). This net increase in cashflow will go towards 2014 CAPEX - but will still be insufficient to offset declines and need for further production growth. My bet is they will use the increase in 2013 cash - and additional funding - to ride out this storm then surprize the market with a big uptick in CAPEX for 2014 assuming the current trends continue.
CIBC research is assuming CAPEX at $720M for 2014 - virtually flat from 2013 levels of $675M - I think this number is vastly underestimated. Management is aware they need to spend to offest declines and boost BOED production per day to improve cashflows and maintain growth. If they chose to fund CAPEX in 2014 with more debt - this will further strain debt levels - current drawn portion on thier LOC assuming they use accordian feature to $1.5 Billion is already at 60% ($900M drawn) - any further draw against this facility will cause more jitters with the markets around debt sustainability - and I personally agree - this would be an unsustainable level (ie. 80+% drawin on LOC). I trust we have a good management team - and they are acutely aware they do not have leeway to further leverage the balance sheet or current credit faciliites without some negative reaction by the markets (or me for that matter!).....
My long winded conclusion......
.....the only meaninful way to reduce debt is sell assets - and management knows this - and they are sitting on billions worth of it. Management cannot borrow to increase CAPEX for 2014 to meaninful levels without destroying the balance sheet to offset declines. They may be able to defer an asset sale to 2014 if they truly have a banner 2013 year which is possible (ie. $800M+ cashflows) and keep Debt to Cashflow ratios under 3x which the markets are looking for - but eventually - the debt needs to be reduced to get CAPEX and dividends (total payout) to within 90% to 110% total payout (versus approx 130% this year and 166% last year with DRIP) given base declines and and need to spend more just to maintain current production levels. Ideal situation is when PBN is fully self funded - dividends and CAPEX out of cashflows with total payout less than 100% (which I think is possible but a few years away - they will need to carry some debt to maintain current dividend and production goals)....but remember - this is a long term play....and when total payout does fall under 100% and they are self-sustaining - my guess is they will eventually start growing the dividends. Sproule, OPEC, EAI, etc - forecast higher energy prices in the coming years....so this scenario (dividend boost in future years) - is plausible.
Selling assets seems to be the only logical and inevitable course of action - I am surprized the analyst community has not picked up on this. The analysts must not think highly of the management team - or they are being overly risk averse (or one may argue - perhaps - that they are the ones who are incompetent with unfounded worries). Whatever the case - I believe this is a competent management team with years of combined experience - they are smart, balanced and methodical. Moreover - current and past analyst EPS guidance seems to be consistently understated - recent EPS of $0.55 blew estimates away by almost 640% (estimate was $0.13 or so)...and sure enough the next two days the stock soared 14% (one of many reasons I presume)....so the bearish sentiment on PBN earnings and targets seems to have set the bar very - very low.
If I had to make a yet another prediction - if current price, economic, differential, etc. trends continue - management explores an asset sale later this year as prices for both Nat Gas and Oil improves - creating a sellers market and maximizing asset price. I believe the market has not priced this inevidable asset sale into the stock - hence continued worry over debt and dividend sustainability. Bear in mind - if management were not sitting on billions worth of producing and non producing assets and multi-year inventories - I too would be very worried and bearish - but that is what surprizes me - they have plenty of collateral to right size debt levels if they need to and still be in business with years of proven reserves. No one can predict when - but expect a HUGE move upwards when an asset sale announcement comes. To be more precise - asset sale announcement will be towards end of Q4 to coincide with an increase in 2014 CAPEX and improved market conditions.
I will say it again - plenty of upside to this stock relative to downsides - but management is right - now is not the time to be selling assets - I believe management is bang on with the sit and wait strategy despite the hit on stock price - but that clearly does not appease a short term investor. (You would not sell your home in a buyers market with an over-supply of homes - same principle holds true for PBN).
The big unknown is the global economy - and whether this slow growth pace gets drawn out into 2014 - or improves - that would change my analysis completely. The US and China seem to be moving in the right direction based on recent indicators - but Europe continues to be a mess - which can potentially affect global growth and hit oil prices. My take is recent research reports just seem overly bearish but sentiment is becoming more bullish from 3 months ago to now - there have been more upgrades and increased revisions to price targets in recent weeks. From a technical perspective - MACD, Slow Stoch, RSI and other indicators seem to suggest we are moving (albeit slowly) towards an uptrend from a low of $7.6 hit earlier this year - a trend reversal from months of downtrend that started towards the end of 2012.
In the end - people like Buffet made thier money - finding value, being patient (even if it took years) - and then reaping the rewards. We need to do the same.
Disclosures
a) I am long PBN with a sizeable, and growing position
b) I am a CIBC client (hence the citations from CIBC research).
Good luck to all - I have a plane to catch.
PM