PEY.TO - Peyto Exploration & Development

[petec]

Peyto seem to think the new NGTL temporary service protocol is a game changer, as it sorts out access to storage until egress is increased permanently starting 2021:

http://www.peyto.com/Files/PMReport/2019/PMR20191003.pdf

 

Does anyone more knowledgeable than me have a view?

[awindenberger]

Peyto seem to think the new NGTL temporary service protocol is a game changer, as it sorts out access to storage until egress is increased permanently starting 2021:

http://www.peyto.com/Files/PMReport/2019/PMR20191003.pdf

 

Does anyone more knowledgeable than me have a view?

 

No view regarding NGTL, but I've been building a decent position in PEYTO under $3/sh USD. Lower gas prices for longer will help them long term because they actually have a low cost structure.

[petec]

Peyto seem to think the new NGTL temporary service protocol is a game changer, as it sorts out access to storage until egress is increased permanently starting 2021:

http://www.peyto.com/Files/PMReport/2019/PMR20191003.pdf

 

Does anyone more knowledgeable than me have a view?

 

No view regarding NGTL, but I've been building a decent position in PEYTO under $3/sh USD. Lower gas prices for longer will help them long term because they actually have a low cost structure.

 

Agreed.

 

The debt worries me, but the rapidly falling decline rate makes it a lot easier to generate cash.

 

Out of interest, why $3/share? What's your valuation method?

[ValuePadawan]

 

Agreed.

 

The debt worries me, but the rapidly falling decline rate makes it a lot easier to generate cash.

 

Out of interest, why $3/share? What's your valuation method?

 

The way I've been viewing the industry at the moment is that no capital is going into Canadian oil and gas in fact it is running south as quickly as possible eg Encana.

 

Because of their lack of access to capital and lower Aeco prices the last few years only the low cost producers or those who hedged their prices far into the future a few years ago will continue to be profitable. Because of this, capital spending on increasing capacity has shrunk and many companies seem to be on a rice and beans diet and wait until egress comes online. Peyto being a low cost producer is still profitable even after the abysmally low price in the third quarter.

 

If prices stay low for a few years I see Peyto continuing to be profitable as they increase their liquids revenue, pay down debt slowly and pay their dividend which right now is yielding 8ish%. However if egress comes in and prices begin to rise there is considerable upside. I see it as a heads I win tails I don't lose much situation.

 

This is my first post after reading as a guest for years I'm glad to finally be on here and welcome all criticism or opposing opinions.

[awindenberger]

Peyto seem to think the new NGTL temporary service protocol is a game changer, as it sorts out access to storage until egress is increased permanently starting 2021:

http://www.peyto.com/Files/PMReport/2019/PMR20191003.pdf

 

Does anyone more knowledgeable than me have a view?

 

No view regarding NGTL, but I've been building a decent position in PEYTO under $3/sh USD. Lower gas prices for longer will help them long term because they actually have a low cost structure.

 

Agreed.

 

The debt worries me, but the rapidly falling decline rate makes it a lot easier to generate cash.

 

Out of interest, why $3/share? What's your valuation method?

 

Hah, no particular reason for under $3/share. I've been watching PEYTO for awhile and was ready to buy under $10 earlier this year, but got really busy with work and couldnt decide what other position to sell, so I ended up getting lucky to miss most of the last leg down.

 

I agree strongly with ValuePadawan. Right now Peyto as the low cost producer has been able to remain profitable amidst a deep and long lasting bear market, particularly with AECO. They've taken steps to mitigate the pricing issues which will start to kick in more in the next couple years.

 

 

[Nelg]

Peyto seem to think the new NGTL temporary service protocol is a game changer, as it sorts out access to storage until egress is increased permanently starting 2021:

http://www.peyto.com/Files/PMReport/2019/PMR20191003.pdf

 

Does anyone more knowledgeable than me have a view?

 

No view regarding NGTL, but I've been building a decent position in PEYTO under $3/sh USD. Lower gas prices for longer will help them long term because they actually have a low cost structure.

 

As a "patient" owner for some time it seems to me that the new NGTL temporary service protocol ("TSP") could in fact be a game-changer....in that it reduces the risk of negative AECO prices occurring again next summer (funny when you keep lowering the bar).

 

Start with one conundrum: with AECO prices at extremely low prices, you would assume this is due to excess supply, which you would then assume means Alberta's gas storage tanks should be bursting at the seams. However, I understand the storage levels in the main storage facilities connected to the NGTL are at 13-year lows. Something in the market does not seem to be working properly, and since the NGTL transports the overwhelming majority of produced gas in the province, it probably has something to do with that.

 

Peyto's monthly letters in the last few months talk about this issue a lot, but here's my understanding - would be great if anyone can correct me and/or provide extra nuances!

 

TransCanada/TC Energy ("TRP") has always prioritized shippers with long-term contracts vs intermittent/short-term contracts. Generally, shippers with long-term contracts would typically be very large E&P companies who would ship their produced Alberta gas and ship it through TRP's Mainline which goes out to eastern markets, where the E&P-co might have a supply contract with a large utility. Shippers with intermittent/short-term contracts would normally sell to marketers who would buy the gas, fill it up in AECO-connected storage facilities and/or sell it in local markets.

 

Prior to July 2017, TRP used to scale back the long-term shipper volumes in the summer months (low demand), and allow the short-term shippers to get volumes onto the NGTL which would then be stored in AECO-connected storage tanks in southern Alberta. This gas inventory would then be used during the high-demand winter months.

 

In July 2017, TRP (with regulatory approval) said they won't be scaling back the long-term shipper volumes during the summer months anymore. This meant that if you weren't one of the large few companies that signed long-term NGTL contracts (to then ship it on TRP's Mainline out east), you couldn't reach storage facilities anymore because you couldn't get onto the NGTL. Combine this with unscheduled outages, maintenance, etc, and this made it even more difficult to reach storage facilities. You can see a NYMEX HH vs AECO chart and see the differential volatility blows up after 2017.

 

With the TSP, TRP basically agreed to go back to the pre-July 2017 service protocol for (1) the month of Oct 2019, and (2) April - October 2020 summer months. In 2021, Peyto/Darren thinks the extra NGTL capacity should be more than enough to service both long-term and short-term shipper volumes, leading to at least "normal"/stabilized AECO prices.

 

Unfortunately or fortunately depending on your perspective, the post-October TSP storage levels are still extremely low (and I think there may still be some uncertainty over how easy it is for the stored gas to again get onto the NGTL to supply the province during the winter months), leading some in the industry to believe we're in for a wild ride this winter. In one oilfield services company conference call, the CEO mentioned he has a steak bet with one of his VPs that AECO will go over $7.50/GJ this winter.

[petec]

That fits my understanding but adds clarity and detail. Thanks.

 

I have a fairly basic model that tried to calculate free cash yield after capex required to maintain production flat. Last week Peyto’s yield was 50% on this measure, using spot pricing. If next summer is better than last summer, it’s dirt cheap.

[awindenberger]

That fits my understanding but adds clarity and detail. Thanks.

 

I have a fairly basic model that tried to calculate free cash yield after capex required to maintain production flat. Last week Peyto’s yield was 50% on this measure, using spot pricing. If next summer is better than last summer, it’s dirt cheap.

 

I am quite confident that in 2-3 years people will be shocked that PEYTO ever got this low.

[petec]

I am inclined to agree.

[ValuePadawan]

Does anyone have a bear case for Peyto? If so I'd love to hear it.

 

I feel like I am among like minded people in seeing it undervalued but if there's a contrarian out there with reasons for instance why AECO prices will go low and stay low or why the debt is a major danger to the company or anything like that I'd love to hear that side of the story if there is one.

[petec]

Does anyone have a bear case for Peyto? If so I'd love to hear it.

 

I feel like I am among like minded people in seeing it undervalued but if there's a contrarian out there with reasons for instance why AECO prices will go low and stay low or why the debt is a major danger to the company or anything like that I'd love to hear that side of the story if there is one.

 

Agreed I would love to hear from a bear. I think the debt is much less of a danger now declines are in the low 20's (meaning less capex needed for maintenance and more FCF) than it was when declines were 35%.

[awindenberger]

Does anyone have a bear case for Peyto? If so I'd love to hear it.

 

I feel like I am among like minded people in seeing it undervalued but if there's a contrarian out there with reasons for instance why AECO prices will go low and stay low or why the debt is a major danger to the company or anything like that I'd love to hear that side of the story if there is one.

 

Agreed I would love to hear from a bear. I think the debt is much less of a danger now declines are in the low 20's (meaning less capex needed for maintenance and more FCF) than it was when declines were 35%.

 

The bear scenario is that current prices continue forever, or even decline more due to lower demand. My day job is in the solar industry, and I fully expect renewables such as solar and wind to replace fossil fuels at a much faster rate than most think over over the next couple decades. Oil will feel the largest brunt as EVs replace combustion engines, but significantly higher secular long term prices on fossil fuels are very unlikely in my mind (cyclical price increases will still occur and could be strong over the next 2-5 years).

 

Natural gas will be the last fossil fuel to be hurt, as it is cleanest burning and higher electric demand will be good for its growth until renewable costs decline enough to fully overtake it. Thats why I like Peyto as the lowest cost producer in one of the most depressed markets. They will be last man standing if bear market in gas continues another couple years.

[mcliu]

Devil's advocate:

Is Peyto still the lowest cost? The other producers have all reduced cash costs over the last 3 years and larger players like TOU, VII, CNQ have much better balance sheets.

The industry is also being kept alive by low interest rates, so unless we see more bankruptcy, production cuts, it might be a while before prices can recover. Meanwhile, west-coast export potential is up in the air and US production is still going strong.

[SharperDingaan]

Worth considering …..

 

Today's oil producing shale field is tomorrows gas field.

As the wells age the gas cut gets progressively bigger, and the gas is considered by-product. The closer the field is to both a pipeline & the user/export point, and the more egress capacity there is - the less incentive there is to raise value. As long as you can get > cost, just dump and take the cash. Most would expect that over time, gas from US shale will displace Cdn south-bound US exports, and lower world prices.

 

Locality matters.

We might hate environmentalists, but in the WCSB it means burning large quantities of cleaner gas to extract bitumen &/or produce electricity, under a lower carbon footprint. A close user, and limited US ingress, that should support local pricing. We also have repetitive cold winters clearing inventory.

 

Lowest cost production is great - but only temporary. Shale gas by-product costing will be a challenge.

The obvious solution is a future consolidation within 'spent' shale fields - become the dominant enough producer to impose supply restrictions in support of higher local prices.

 

SD

 

[Nelg]

Devil's advocate:

Is Peyto still the lowest cost? The other producers have all reduced cash costs over the last 3 years and larger players like TOU, VII, CNQ have much better balance sheets.

The industry is also being kept alive by low interest rates, so unless we see more bankruptcy, production cuts, it might be a while before prices can recover. Meanwhile, west-coast export potential is up in the air and US production is still going strong.

 

I'd personally compare Peyto with VII and TOU which as you note are also quite well run.

 

I measure "low-cost" by comparing netback % margins excluding hedging, which generally gives me a sense of how much they'll hurt if commodity prices fall further. (Netback % margins because I don't really care whether they are "liquids-rich" or "oily" or "gassy" or "<insert lingo>", I just care about margins. I exclude hedging because hedges eventually run out. I recognize you should also compare capital costs, which I still look at closely but it's somewhat burdensome to calculate it for every company, and high-margin production is usually correlated with low F&D costs.)

 

Not sure how to post tables/pictures here but below are the 3Q 2019 comparisons, all in $/boe and all excluding hedging:

TOU (81% gas): Realized Prices $15.74 vs Field Netback $8.32 (53% margins) and Corporate Netback $7.18 (46% margins)

VII (42% gas): Realized Prices $32.16 vs Field Netback $18.90 (59% margins) and Corporate Netback $16.13 (50% margins)

PEY (86% gas): Realized Prices $12.79 vs Field Netback $9.58 (75% margins) and Corporate Netback $7.43 (58% margins).

(and for other reference)

OBE (33% gas): Realized Prices $38.64 vs Field Netback $18.15 (47% margins) and Corporate Netback $10.17 (26% margins)

BNP (69% gas): Realized Prices $12.11 vs Field Netback $4.82 (40% margins) and Corporate Netback $2.37 (20% margins)

 

TOU/VII have cleaner balance sheets as you noted, which is why Peyto's field netback margin outperformance > corporate netback margin outperformance. This is generally due to TOU/VII's (1) historical willingness to issue common equity to fund growth, with TOU and VII increasing share count since 2015 by 23% and 32%, respectively (vs +4% for Peyto), and (2) lack of historical dividend payouts with only TOU recently starting to pay a modest dividend (vs Peyto historically paying out ~$200m/year during the heydays).

 

In hindsight, Peyto would have been FAR better off to raise some equity in ~2016 (a ~10% dilution at the time would now be enough to cut current debt levels in half!), and I am personally surprised they've allowed leverage to get this high (3x vs 3.25 covenant, as of 3Q 2019) though at the current forward curve they should be deleveraging to ~2.5x in the next couple quarters, by my calculations. 

 

At the current forward curve I'm calculating 2020 FCF (maintaining production flat) of ~$140-$150m (before financing activities) which works out to a ~30% FCF yield. What I don't understand, is if they're comfortable with their leverage as they say they are, why they choose to maintain the 10% dividend yield instead of using that capital to repurchase shares. After capex (which it sounds like they'll be increasing now) buying back shares must surely be a more efficient use of capital vs paying out $40m/year in dividends. Maybe I should just switch my PEY for VII which is doing just that...but then I will miss reading Darren's monthly letters!  :-\

[petec]

Great post, thanks.

 

I hold this investment in a tax free account so I can just use the dividends to buy more shares. I always think the distinction between buybacks and dividends is overplayed.

[petec]

Worth considering …..

 

Today's oil producing shale field is tomorrows gas field.

As the wells age the gas cut gets progressively bigger, and the gas is considered by-product. The closer the field is to both a pipeline & the user/export point, and the more egress capacity there is - the less incentive there is to raise value. As long as you can get > cost, just dump and take the cash. Most would expect that over time, gas from US shale will displace Cdn south-bound US exports, and lower world prices.

 

 

I agree - but assuming gas can move the impact will be felt where prices have historically been high relative to US prices (e.g. Asia), not where they are low (AECO).

 

So the question is: can gas move? Because if it can, AECO will close the gap to NYMEX, and is quite likely to rise in absolute terms, even while Asian prices (and possibly NYMEX) fall due to the dynamics you describe.

 

It seems to me that egress from the WCSB grows in 2021-23. The company's presentation claims that NGTL expansion and LNG Canada require production to go from 16b's a day to 21b's over 5 years, against a decline rate of 4b's a year. The previous record production level is 18b's. That would underpin AECO pricing and a very nice outlook for Peyto at these share prices.

[petec]

At the current forward curve I'm calculating 2020 FCF (maintaining production flat) of ~$140-$150m (before financing activities) which works out to a ~30% FCF yield.

 

Would you mind sharing the details of this calculation?

[Nelg]

At the current forward curve I'm calculating 2020 FCF (maintaining production flat) of ~$140-$150m (before financing activities) which works out to a ~30% FCF yield.

 

Would you mind sharing the details of this calculation?

 

2020 assumptions below. Although some of the assumptions' numbers look quite specific, most are just eyeballed from historical numbers. I almost never create models for my investment, but I have some background in E&P so could not stop myself.

 

Macro stuff (forward curve as of Nov 29):

AECO: $1.84/GJ = $1.94/Mcf

WTI: US$56.50/bbl = C$61.02/bbl

 

Pricing:

Realized Oil/NGLs prices excl hedging as % of CAD WTI: 55% (2017 was 76%, 2018 was 67%, 3Q 2019 was 50%)

Realized Gas prices excl hedging as % of AECO (Mcf basis): 125% (2017/18 was ~110%, 1Q 2019 was 122%, 2Q 2019 was 150%, 3Q 2019 was 141%. This is one of the things I don't quite understand. They talk a lot about how they've diversified the markets they sell gas to...but basically all companies are doing this. The difference is other companies usually have big increases in transportation costs to achieve this whereas Peyto has not. Anyway, if they continue to realize material premiums >125% of AECO then that's good, and if they don't, well then that's bad.)

Hedges: Only their CAD WTI and AECO hedges as of 3Q 2019 taken into account. I'm too lazy to model the basis swaps. 

 

Capex and Production:

Production mix: approx unchanged from 3Q 2019 (~14% oil and liquids)

Decline rate vs 4Q 2019E: 24% (I think someone mentioned it's in the low 20s? I believe Darren has mentioned it in previous letters)

Capex efficiency: $11,000/boe/d

Capex: $200m

Production: ~77mboe/d (with these assumptions, ~$200m of capex should be enough to keep production flat)

 

Operations stuff:

Royalties: 2.9% of realized prices

OpEx+Transportation: $3.09/boe

G&A: $18m

Working Capital: no changes

 

 

 

 

Financial summary

Revenues net of royalties and incl hedging (latter of which turn out to be immaterial at the assumed benchmark prices): $492m

less OpEx & Transportation: $87m

less G&A: $18m

= EBITDA: $387m

 

less Interest: $42m

= FFO: $345m

 

less Capex: $200m

= FCF: $145m

 

Capital allocation: assume they use the $145m of FCF in the following way: $40m dividends, remaining $105m to repay debt (hence the deleveraging).

 

So obviously not all that FCF would go to shareholders, so maybe the ~30% FCF yield comment is slightly misleading (though there should be quite a bit of value that accrues to equity because the risk of covenant breaches decreases, etc etc)...but that $145m should be increasing in the following years due to an upward sloping forward curve.

 

I personally think Peyto should deleverage ASAP to below 2x, as this should allow them to weather declining prices for a longer period of time. If AECO drops to say around ~$1.50 next year, they will very likely need covenant relief which isn't the end of the world as I think it'll still be under 4x and this should be palatable to lenders/bondholders...but why risk going there?

[ValuePadawan]

Thank you so much for the detailed calculation.

 

I couldn't agree more when it comes to paying down debt to get their balance sheet to a more conservative position. I'd rather they protect the downside because if they do that the upside should take care of itself.

[SharperDingaan]

"So the question is: can gas move? Because if it can, AECO will close the gap to NYMEX, and is quite likely to rise in absolute terms, even while Asian prices (and possibly NYMEX) fall due to the dynamics you describe."

 

Big question.

 

Assume it doesn't, oil-sands use will set the lower price bound, with weather-related interruptions. Higher growth-related demand (more oil-sand & stripping) offsetting higher shale supply, reducing price volatility.

 

Near/Medium term movement depends on both user location/quantity, and egress point. Piping direct to a large on-shore user is fine, filling tide-water LNG carriers - not so much. Few tolerate floating bombs in their harbors.

 

Long term movement depends on geography/vision. Canadian NG should really flow NORTH to the Beaufort Sea, and not SOUTH or WEST to Asia. We would get a location premium to world price, be the natural supplier to most of the northern nations, and can still export to Asia - but this time from a remote egress point. Lot of other benefits as well.

 

SD

 

 

[petec]

FWIW, my version of Nelg's maths...

 

Gas price: 50/50 weighting of the AECO summer and winter strips, which run from April 2020 to March 2021 = $1.80/GJ

NGL price: Edmonton propane spot = $55

 

GJ/mcf conversion 1.15.

Production 77kboe/d.

14% liquids, 86% gas.

 

Costs/mcf: $0.85

 

Operating cash flow =  $370m.

Decline rate 25% (from latest presentation).

Capex intensity $10k/boe (historically higher but that includes building gas plants, in which they now have excess capacity).

Capex to hold production flat = $190m.

 

Free cash flow at flat production: $175m, yield 38%.

 

I built this a year or so ago as a very rough guide - if there are any embarrassing errors please let me know.

 

BTW I tend to think that FCF used to pay down debt does accrue directly to shareholders. Assuming enterprise value does not change, lower debt means higher market cap; and one could argue that as debt falls risks also fall and the ev/ebitda multiple should rise, raising the enterprise value and magnifying the impact on market cap.

 

EDIT: three further observations. 1) $0.85/mcfe for cash costs is probably too low. $0.90 is likely nearer the mark - but 25c of that is interest costs which will fall. 2) transport is $0.17 of this, and this has been flat as production has fallen, so transport costs are rising, albeit not as much as one might have assumed given the sales mix. 3) p21 of the latest presentation suggests that at least part of the excess of realised price over AECO is due to heat content.

 

 

 

 

 

 

[ValuePadawan]

What are y'alls opinions on dividends vs buybacks?

 

Personally at these prices I think cash should be used to lower debt and buy back stock but because most E&P shareholders expect dividends I don't think management will do this. Even if they chose a middle option giving 10M in dividends and the rest split between debt and buybacks (mostly debt) I think that would be more value added than their current all dividend approach to returning capital.

 

Anyone have contrary opinions? I'd love to hear them.

[petec]

What are y'alls opinions on dividends vs buybacks?

 

Personally at these prices I think cash should be used to lower debt and buy back stock but because most E&P shareholders expect dividends I don't think management will do this. Even if they chose a middle option giving 10M in dividends and the rest split between debt and buybacks (mostly debt) I think that would be more value added than their current all dividend approach to returning capital.

 

Anyone have contrary opinions? I'd love to hear them.

 

Personally I'd favour debt paydown.

 

Dividends vs buybacks is entirely a tax question. If tax treatment was the same, investors could simply buy more shares with the dividend and achieve the same result. Your preference will therefore depend on your tax situation. I own this in a tax free account so I couldn't give a fig about buybacks. The question is simply: capex vs debt paydown vs return to shareholders and personally I think they currently weight a little too much in favour of returning cash rather than paying down debt.

 

Then again if I was looking at a 40% increase in local demand against a backdrop of falling local supply (see p17 of current deck) and had a 50-year drilling inventory (p29) I might also have the confidence to maintain my leverage in anticipation of the coming upcycle...

 

 

[finetrader]

Hello Peyto,

 

How low can you go?