Changing Guard in Canadian Energy Stocks

05/02/2012 10:30 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

I’ve held these two energy stocks for a long time, but given the current energy environment, it’s time to walk away from these picks and put the money to work in stocks with a better track on the future, writes Roger Conrad of Canadian Edge.

It’s time for a double switch.

Move one is to swap out Enerplus Corp (ERF) for Pengrowth Energy (Toronto: PGF), an energy producer with virtually the same business, but that appears far less exposed to the recent crash in natural gas prices.

Move two is to exit long-time underperformer Penn West Petroleum (PWE) for similar yielding but much faster growing PetroBakken Energy (Toronto: PBN).

Why Pengrowth for Enerplus?
It’s all in the numbers. Pengrowth’s fourth-quarter payout ratio was 42% of funds from operations, the primary measure of profits from which dividends are paid. That’s well below Enerplus’ 68%. Including capital expenditures, Pengrowth’s payout ratio was 124.8% for the quarter, versus 182.7% for Enerplus.

Moreover, Pengrowth’s fourth-quarter funds from operations per share rose 14%, while Enerplus’s actually sank 5.4%.

Enerplus’ operating costs were lower than Pengrowth’s, at C$11.64 per barrel of oil equivalent against C$14.63. But Enerplus’ operating costs were 38.2% higher than last year’s. Pengrowth’s, meanwhile, were actually 2% lower than year-earlier levels. And costs would have been considerably lower for full-year 2011 were it not for extreme wet weather and flooding in the first half of the year.

As for exposure to falling natural-gas prices, Pengrowth’s revenue from oil and gas liquids sales rose to 77% of total sales in 2011, from 70% in 2010. That’s against 67% for Enerplus. Pengrowth’s exposure fell to just 19.5% of revenue in the fourth quarter, and is set to shrink further once the company completes its merger with NAL Energy (Toronto: NAE).

Adding NAL will make Pengrowth the second-largest intermediate producer in Canada, behind Penn West. Announced in late March, the deal needs approval of Canadian antitrust regulators as well as two-thirds of shareholders of both companies during votes slated to be cast in late May 2012. Close is currently expected by May 31.

To get NAL, Pengrowth is paying less than a 10% premium to the target’s pre-deal price. The appeal to NAL holders is an immediate 20% dividend increase, with the promise of more as part of a well-managed company with exit production of 100,000 barrels of oil equivalent per day by the end of 2012.

Pro forma output for the combined company is expected to average 86,000 to 89,000 barrels of oil equivalent per day for all of 2012. And Pengrowth’s operating costs are expected to decline to C$13.75 per barrel.

Interestingly, Pengrowth’s projected capital expenditures for 2012 will hold steady after the merger. The company will simply focus resources on light oil reserves in Swan Hills, the central Alberta Cardium trend, and southeast Saskatchewan, as well as the Lindbergh oil sands project.

These efforts will provide further boost to output of liquids and reduce dependence on natural gas—and without adding to debt other than $200 million of the company’s existing credit line that will be drawn at closing.

I’ve been a fan of Enerplus and its management team for some years. I’ve tracked it for more than a decade, beginning in Utility Forecaster. But at this juncture, however, plunging natural-gas prices make Pengrowth the higher-percentage bet.

Yielding more than 9% and selling for less than book value, Pengrowth Energy is a solid buy.

And Now, Why PetroBakken?
My primary reason for preferring PetroBakken to Penn West is simple: output growth.

PetroBakken posted record fourth-quarter production of 48,007 barrels of oil equivalent per day, averaging 50,250 per day in December and topping exit production targets. December output was 18% ahead of last year, while full-quarter production was up 23% on a sequential basis.

This added up to a 52% jump in PetroBakken’s funds from operations per share over third-quarter levels, and 45.9% over year-earlier levels. And it took the company’s fourth-quarter payout ratio down to just 19%.

Penn West did meet the mid-point of management’s output target for 2011. And it increased funds from operations by 43% over fourth-quarter 2010 levels, driving the payout ratio down to just 29%.

The gains, however, were almost entirely due to a 25% increase in oil and natural-gas liquids prices, as well as a 20% jump in heavy oil prices. Actual production rose just 2%.

PetroBakken’s proved-plus-probable reserves were increased 19%, as it replaced 2011 output by 315%. The company also invested $909 million last year, with wells drilled showing a 99% success rate.

The largest percentage production gain was a 37.3% jump from the Cardium light oil trend. But the company also enjoyed a 10% boost from its Bakken properties, which still contribute nearly half of total output.

Operating costs in the Bakken were just $9.11 per barrel of oil equivalent in the fourth quarter, among the lowest for any oil producer in North America. Company-wide production expenses were $10.97, up 22% from fourth-quarter 2010 but a significant improvement from levels earlier in the year.

Penn West, meanwhile, replaced 230% of reserves, but only before natural-gas price revisions and asset dispositions. And operating costs surged to $17.48 per barrel of oil equivalent, up 10% from year-earlier levels.

Penn West’s recent numbers did demonstrate the company is getting back on track from production troubles that raised costs and depressed output in 2011.

PetroBakken, however, is growing faster, pays basically the same yield as Penn West—monthly, rather than quarterly—and arguably has just as strong a balance sheet. PetroBakken is a buy

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