In January's oil-price depths, Penn West Petroleum Ltd.'s shares hit $1.72; 10 days later, they'd doubled. Even with a recent retreat, they're still more than a buck above their low.
Does that mean the worst is over for the beleaguered Calgary-based company? Likely not. Investors take comfort in the fact the company still has borrowing capacity under its bank loans, and only a small fraction of its $2.2-billion in debt comes due in the next year.
The company, however, now acknowledges it will likely need to have a chat with its lenders this year about its debt covenants, which require a certain level of earnings, a level the company probably won't meet. At the same time, the company's long-term plan to shore up its balance sheet through asset sales is increasingly in jeopardy in an environment where uncertainty about oil means deals are grinding to a halt.
While the lenders would seem to want to keep Penn West a going concern, it's time for investors to consider whether the company might pursue a debt restructuring plan that drastically cuts shareholders' stake – perhaps close to zero.
I examined Penn West in Vox last year, arguing that its history of acquisitions at the robust prices of better times had created a massive amount of the financial asset called "goodwill," and that a writedown was in order.
That was in September, when oil was nearly $95 (U.S.) a barrel, seemingly another world away from today, when it's struggling to hit $50. And any kind of goodwill writedown has slipped rather far down the list of Penn West's concerns.
The company announced its 2015 plans, including a sizable dividend cut, in December. Penn West said it expected "funds flow" of $500-million (Canadian) to $550-million, before a capital budget of $625-million.
Those figures, however, were based on a $65 price for Canadian crude oil, which is about $15 more than it trades at today. Edward Vranic, a Toronto-based retail investor and chartered financial analyst, authored a skeptical post on the company on the website Seeking Alpha. "It does not appear likely that Penn West will be insolvent within the next two years, even with oil prices remaining low," he writes. "However, [the company's] 2015 forecast of free cash flow is around [negative] $100-million at an oil price assumption that is 37 per cent higher than January's average price. I suspect that the banks will be hesitant to continue with the credit facility as is – given the low oil price and high exposure they would have to other oil company debt."
Perhaps a good suspicion. At the CIBC Whistler Institutional Investor Conference on Jan. 22, Penn West CEO Dave Roberts said the company has a covenant that says its senior debt cannot exceed three times its EBITDA, or earnings before interest, taxes, depreciation and amortization, and "that is going to be a problem this year – there's no question about that, and we're being very upfront about it."
"It's not a solvency issue, and one of the things we're really stressing to people is we run a solid company that makes 100,000 barrels a day … even at these [price] levels, this is a company that generates levels of EBITDA we think we should be able to carry through."
The company "is having conversations with bondholders … and I expect them to want to work with us," Mr. Roberts said.
When companies and bondholders work together, however, shareholders often come up short. Mr. Vranic likens Penn West's situation to Yellow Media, which had grown by buying assets, but began to sell them off when cash flow began to decline. As it began to seem as if Yellow Media might eventually violate covenants, it engaged its creditors. At the time, some analysts said the company had a lot of wiggle room. About 14 months later, Mr. Vranic notes, Yellow Media entered into a debt restructuring plan under the Canada Business Corporations Act, and the shareholders who stuck with the company have about eight to nine cents of stock in the new Yellow Pages Canada for every old share (at one time worth $20) they once held. "Yellow Media is a lesson in how quickly things can turn from bad to worse," he says.
There's no guarantee we'll see an exact replay at Penn West, of course. We could be surprised by a quick and sharp rebound in the price of oil, and the company's shares could lift past $3, to $5 and beyond. The very real risk, however, is that Penn West's covenant issue becomes a much larger problem for investors using the shares to bet on oil's comeback.
David Milstead