Peyto Exploration & Development (PEY.CN) remains our best long idea among North American E&Ps, as it has been since May 2012. We think it’s the best run E&P company, as well as the best risk-adjusted return opportunity, in the entire sector; the 1Q13 results released last night strengthen our conviction.
On the Quarter and Outlook
Peyto delivered another solid quarter with production increasing 11% sequentially to 332 MMcfe/d (89% natural gas). Cash costs came in at $1.01/Mcfe, which is, again, industry-best.
Current production is just over 61,000 boe/d and Peyto has another 5,000 boe/d “behind pipe” that will be brought on as soon as break-up is over (late May). Assuming some natural decline over the final month of break-up, Peyto should be producing ~64,000 boe/d when those volumes come on-line in June/July. Year-end 2013 guidance is 62,000 – 67,000 boe/d, but at this point we think 67,000 – 70,000 boe/d is more realistic given where production will be exiting break-up, and the Company’s plan to run 10 rigs all summer and possibly throughout the fall and winter (pending capital efficiencies). If Peyto does run 10 rigs for the rest of the year (as opposed to the original guidance of 9) we expect full-year capex to come in ~$550MM vs. the $450 – $500MM guide. With AECO gas around $4.00/Mcf and activity levels in western Canada muted, Peyto is in the sweet spot, and we like to see the Company putting as much capital to work as it can, without compromising efficiency.
The big news in the quarter was the 33% dividend increase from $0.72/share annualized to $0.96/share annualized. We have mixed feelings about the decision – no doubt it will be applauded by the large Canadian investor base which holds dividends near-and-dear to its heart (a sentiment that we do not personally share, but whatever, to each his own), but good stewards of capital (return focused) are rare in the E&P sector and with Peyto being one of the best, we’d like to see that incremental $36MM per year invested back into the asset base.
However, we do appreciate that Peyto is growing production 30-40% per year and this year’s capital budget and 10 rig program is the largest in the Company’s history… Oh yeah, and that it’s doing this with only 40 employees and an annual G&A budget of ~$12MM (including capitalized G&A).
Peyto will be generating free cash flow in 2014, and there’s no reason to pay down the 3.5% credit facility. If the Company believes it’s growing as fast as it sensibly can, we’re in no place to doubt it, so perhaps the dividend increase was the second best option (we like buybacks better). Regardless, the fact that this is even a debate is a good thing.
Too Expensive? Broken Record
We get a lot of push back on valuation on Peyto – almost everyone tells us that it’s “too expensive”. We heard it at $18/share and we hear it today at $29/share. Frankly, valuation is one of the last things we consider in this sector because E&P NAVs involve so many assumptions that they’re almost arbitrary, and cash flow multiples can be misleading, as stocks are a claim on decades of earnings, not one year (COG and FST are great examples of misleading multiples). In this sector, cheap often gets cheaper and expensive stays expensive. Peyto’s industry-low cost structure, commitment to profitable growth (returns), unique corporate culture of creating shareholder value, and decades of drilling inventory is why we’re so bullish on this name. If any of that changes, that’s when we’ll sing a different tune.
Stats that Matter
- Production: 332 MMcfe/d, +35% y/y (per share +26% y/y) and +11% q/q
- Production mix: 89% gas/11% liquids, flat q/q. New liquids volumes from the Oldman Deep Cut facility were offset by a higher percentage of Falher and Wilrich wells drilled, which are deeper/gassier zones than the Cardium.
- Operating expenses (incl. transportation): $0.43/Mcfe, down $0.02 y/y and +$0.01/Mcfe q/q
- G&A expense: $0.02/Mcfe, down $0.02 y/y and flat q/q.
- Interest expense: $0.21/Mcfe, down $0.02 y/y and down $0.11 q/q.
- Funds from operations (discretionary cash flow) were $103MM, or $0.69/share.
- Capital expenditures were $167MM.
- Net debt at end of Q: $750MM, +$88MM from 12/31/12