Another mid-stream Canadian oil and gas producer bites the dust – Pengrowth Energy

… I’m not talking about Ovintiv either (TSX: ECA), which is pretty much an admission that any dot-com name for a company has already been taken up, so companies now have to resort to pharmaceutical-style naming conventions for their firms.

Pengrowth (TSX: PGF), which I have written about extensively in the past on this site, announced on Friday they were going to accept a takeover bid of CAD$0.05/share plus the payout of debt. The amount of debt outstanding was approximately $700 million and the total purchase price is $740 million.

The effect on their stock price was fairly dramatic:

It reminds me of the expression I tell people around me when they mention that something is cheap at 20 cents per share – “When it goes to zero, your loss is always the same – 100 percent”. In this case, investors took a 75% haircut on the last Friday of trading after the announcement.

This is the next (former) mid-tier oil and gas player to effectively go belly-up, the previous one being Bellatrix Exploration. At the rate things are going, only Suncor will be the last one standing in Canada.

The buyout of Pengrowth is going to be interesting for a couple reasons.

One is that the press release does not make mention in any way of any shareholder consent agreement from Seymour Schulich, who owns 28% of the company. Perhaps he is planning on taking a huge capital loss. One does not do big merger deals without getting consents from major shareholders with deep pockets, so the absence of this is very mysterious. To reverse the merger will cost some other suitor $45 million dollars – in light of the existing deal, this is a huge windfall that would be paid out if somebody were interested in the assets.

However, I deeply suspect in the shopping around process they couldn’t find anybody that was willing to finance the company at an acceptable price. The management information circular that will come out should yield some further clues on the process they undertook.

The other is how the deal is structured – Cona Resources used to be public, but it was majority owned by the Waterous Energy Fund, which is relatively secretive in its dealings (it is private). Waterous took its minority share of Cona private in May 2018 and we can infer from its SEDAR filings that were available that this entity is still not making money. Cona was bought out at about 45% of book value ($2.55/share on 101 million shares) coupled with $332 million in debt.

That said, Pengrowth, stripped of its leverage situation, actually makes money. Not a lot (especially in the current Canadian context), but while I am not surprised that shareholders are taking a massive bath on the company, I am surprised that this is the best agreement they could find. I am guessing the existing debt holders were completely unwilling to consider a debt-for-equity swap.

If Canadian oil and gas does come back from the dead, however, Pengrowth’s thermal oil assets are top notch and Waterous will be making a mint on this one. They effectively are going to wait this one out until the climate gets better. Parking $740 million of capital to do this seems like a reasonable gamble. I can see why they made it.

My last position in Pengrowth was in their unsecured convertible debentures, which matured at par in early 2017. I’ve been tracking it ever since and have taken no positions in their stock.

Genworth MI Q3-2019: Steady as she goes

I’m catching up on quarterly reports, so these posts are coming in a little late. This will be a short one.

Genworth MI (TSX: MIC) reported their third quarter results. They are largely unsurprising and they continue to be a cash machine as there have been no material issues concerning the Canadian housing market (as it relates to the mortgage-insurable side of the business – the high end market in Vancouver, BC is getting slammed because the provincial government is massively increasing the cost of carry for $3 million+ assessed value properties). Loss ratio is 18%, expense ratio is 20%, and they continue to take in a ton of cash simply because mortgage delinquencies and defaults are incredibly low.

As a result in this year, they’ve declared special dividends of $1.85/share so far and also have spent some capital on share buybacks – although since their currently share price is above book, management opts for the special dividend route.

There are only two issues that I will note.

One is that there is a brief mention of the impact of transition away from Genworth Financial’s shared services – since MIC’s majority stake (56.9%) is being bought out by Brookfield Business Partners, MIC will have to build its own services currently being purchased from Genworth, and this will cost money. It is also not entirely known about the exact impact of this, whether Brookfield intends on using Genworth MI as a currently existing cash machine, or whether they have strategic plans for the entity. The common shares are also at $53, which is significantly above the book value of $46 (which historically has been a rare situation) and it is almost as if the market will expect a follow-on bid to take the rest of the 43% out of the market. We will see.

The other note is that the company’s portfolio of preferred shares has also been a victim of the 5-year rate reset plague which has depressed prices of such preferred shares – they are now sitting on a $107 million unrealized loss on their current fair value of $494 million – or 18%.

Otherwise, the company seems to be doing very well. There does not appear to be any hints that CMHC wishes to apply any semblance of pricing pressure in the marketplace, which would be the biggest risk to MIC’s share price. One would have presumed that the Government of Canada would want to make life more affordable for the middle class homebuyer, but I am the first one to know that the words coming out of politicians’ mouths should always be verified by the actions of the bureaucracy underneath them!

Altagas Canada – my worst missed investment

I’m going to talk about the Canadian election results in a subsequent post. Something more mundane here.

Altagas Canada (TSX: ACI) was spun off from Altagas (TSX: ALA) in the depths of ALA’s de-leveraging attempts. Unfortunately, this was my worst “miss” that I never invested in, because of my normal policies which go against investing in initial public offerings. Altagas went public at $15 in October 2018 and I was intending on buying shares when it inevitably dropped to $12 (if I was going to buy a new public offering, why would I pay face value?), but it never got there. Sadly, my parsimonious nature got the better of me.

There is a second rule which I should have remembered: If a company goes public as a result of a forced de-leveraging or firesale, it probably is worth a consideration beyond that of a more standard IPO. Another IPO that fit this description was Genworth MI, which was spun off from Genworth Financial (NYSE: GNW) for deleveraging purposes. They do not happen very often, but when they do, you get gains like what happened with ACI.

ACI received a buyout offer from the Federal public pension board and the Albertan pension plan for CAD$33.50/share, so if I had just sucked it up and bought shares on IPO day at $14.53, I’d be sitting on a 130% gainer in the span of a year, not factoring in the $1.04 dividend. Oh well!

In terms of valuation, the pension plans are buying for a billion in cash a company that also has net $640 million in debt on the balance sheet. At an EV of $1.6 billion compared to 2018 operating cash flow of $90 million (not even factoring in capital expenditures), this isn’t the cheapest acquisition on the planet. It’s easy to see why they agreed to be bought out, and also why I wasn’t interested in them for $25/share either!

This, however, does show that pension boards are looking for cash flowing assets to park their capital into. Looking at Atlantic Power (TSX: ATP) anybody?

Canadian election, impact for stocks

Right now, 338 Canada has the following:

LIB 136 ** rounded down from 136.6 to make the total 338 seats
CPC 123
Bloc 39
NDP 36
Green 2
PPC 1
IND 1 (Jody-Wilson)

If this is the outcome, it is quite probable the Liberals will get together with the NDP, either in a coalition (where NDP ministers get appointed) or unofficially (similar to in British Columbia where there is a supply agreement that gives the 3 Green Party MLAs more power far above what their electoral standing would otherwise give them).

The implications to this will be fairly clear:

1) TMX is dead
2) BC-LNG will probably face huge hurdles (the Coastal Gaslink natural gas pipeline is provincially regulated) which will probably face regulatory federal barriers… and this will be at odds with the provincial BC NDP government – it will be interesting to see what concessions will occur here.
3) Carbon taxes will be guaranteed to rise, and in general, costs will rise significantly
4) Erosion of the Canadian dollar
5) Probable increases in corporate tax and capital gains taxes

If your money is anywhere around oil and gas in Canada (or pretty much anything for that matter), things will probably get worse.

However, with the surge in the NDP in the polls, this actually bodes well for the Conservatives in certain areas (recall in 2011 that a majority government was obtained with the assistance of the NDP sucking up what would otherwise have been Liberal votes). Because of this and the “shy Tory” effect (where Conservative voters are less likely to report to polling agencies their support), there are alternate scenarios which may surprise people on election day, e.g.

CPC 140
LIB 119
Bloc 39
NDP 36
Green 2
PPC 1
IND 1

In this case you get a CPC-Quebec informal alliance. There is also the outside possibility of a LIB-Bloc-NDP coalition, which was attempted after the 2008 election, which I would not entirely rule out, especially if the CPC can’t get together with the Bloc in any material capacity. There’d be another election in a short time frame to hash things out.

So, various scenarios to look out for:
If LIB > 169, apparently being massively hypocritical and corrupt is rewarded with votes as long as food is on the table;
If LIB+NDP+Green > 169, then it’s a probable Liberal government again, sell everything;
If LIB+Bloc > 169, you’ll still get PM Trudeau, then get ready for Quebec subsidy mania! (pick some stocks on https://divestor.com/?p=8934 and might as well buy some call options on SNC while you’re at it)

The plurality of seats condition kicks in if LIB+NDP+Green or LIB+Bloc+Green < 170, which in that case the CPC would have more seats than the Liberals. Despite news headlines and Justin Trudeau himself (in 2015) saying that the party with the most seats should have the first chance to govern, it isn’t apparent to me that Trudeau will step down until he tries to negotiate some sort of anti-CPC coalition. Watch out for Liberal/NDP headlines saying “2/3rds of Canadians did not vote for a Conservative government” and stuff to that extent to try to make a moral argument why the Liberals should stay in. My guess is that if the Liberals fall 15 seats short of the CPC but still have a workable coalition, they’ll do it. Anything more than a 15 seat difference with the CPC and keeping government becomes more difficult.

The only defense the CPC has (other than an obvious out-right majority) is a CPC+Bloc arrangement (if their seat count is 170 or above). Despite seeming odd to partner with separatists, this was successfully done before: in 1984 and 1988, where the Progressive Conservatives (under Brian Mulroney) successfully formed an internal coalition with the Quebec separatists to win two majority governments. This fractured badly in the early 1990’s and the Bloc Quebecois were created as a result – in addition to destroying the Progressive Conservatives (leading to the uprise of the Reform Party).

A potential CPC+Bloc arrangement will likely involve trading some provincial concessions for energy-positive developments strictly on the west coast of Canada.  It would take shape in the form of provincial autonomy and decentralization of federal powers (closer to what the Canadian constitution was formed as), which was fairly standard Harper-style governance.  The next month will be interesting to say the least.

Aphira is still deeply cash flow negative

I couldn’t resist looking at the financial statements of Aphria (TSX: APHA) since I observed the marijuana sector today has received quite the bid. Today Aphria released their quarterly results and with the following by-line:

Aphria Inc. Announces Second Consecutive Quarter of Profitability and Positive Adjusted EBITDA

Looks good, right? There’s a lot of retail investors in these marijuana stocks, and most of them don’t read the detailed financial statements.

So when glossing over them, I notice this is a textbook case of “announced profits and positive adjusted EBITDA does not mean the company is making money”. Let’s dive further – this is a pretty good case study for beginning investors to learn how companies manage to put the most positive spin on their financial statements.

Look at the cash.

We look at the balance sheet to start with. The first red flag comes in the form of the very decreased cash+marketable securities balance. Sometimes in companies they have to invest initially (e.g. property, plant, equipment) in order to make money. Sometimes companies have large debt payments.

In this case, roughly $22 million went to accounts receivables. Normally receivables should correlate with revenues, but in this case, APHA’s Q1-2020 net revenues ($126 million) were actually LOWER than Q4-2019 ($129 million). Uh-oh…

Inventories and biological assets went up $21 million and $11 million, respectively. (Notes 6 and 7, which we will dive into below).

Capital assets went up $39 million.

All of this accounts for about $93 million of the $105 million cash burn. The rest of it, while interesting, I will disregard for the rest of this analysis – it isn’t the bulk of what’s happening. We’re trying to figure out where the cash is going.

Note 6, inventory:

I will give an example of what is going on here. Just looking at “Harvested cannabis”, the company spent $15.5 million to harvest this. “Capitalized cost” means they converted it into inventory using cash, without it being considered an expense. The “Fair value adjustment” of $20.3 million is management deciding that the value of the harvested cannabis is that much higher, and it can be reflected as such on the balance sheet. The process of doing this is a gain on the income statement, which I will show later.

The questions at this point is whether:
a) Is this estimate accurate? I have no idea.
b) Can the company actually sell this harvested cannabis at or greater than the adjusted value of $35.8 million?

Accounting-wise, inventories are governed by the rules of IAS2, which roughly states that inventories are kept at the lower of cost or net realizable value. These products are distinct from the biological assets, which are governed by IAS41.

Note 7, biological assets:

The key lines here are “Changes in fair value less costs to sell due to biological transformation” and “Production costs capitalized” for $25.2 and $29.8 million, respectively. This is effectively the company deeming that their growing process is facilitating an increase in value of their inventory when it is eventually transferred to that column, but in order to realize this, they need to sell the product!

Note 9, capital assets:

This actually looks reasonable. The company spent $37.9 million on production facilities, equipment, and construction-in-progress, which makes sense if you are a marijuana producer. The quantum of expense can be debated, but the nature of these types of expenses appear in-line with the type of business they are engaged in.

So how does APHA claim profitability?

This dog’s breakfast of an analysis of the income statement drives a couple points:

1) The claimed profits are primarily on the basis of the fair value adjustments through Notes 6 and 7 in the financial statements (to the tune of $17.9 million)
2) And some finance gains on Note 27 (I will not bother getting into this).

In reality, the company is blowing a lot of money on inventory. It is very difficult to take the assertions of profitability seriously unless if you believe that the stated fair value gains on the inventory and biological assets are real and can actually be realized with real sales at the stated values.

I give no valuation opinion at this time other than to state that at $7.10/share (or $1.8 billion market capitalization at 252.7 million diluted shares outstanding) I am not interested in buying.

It took me about 5 minutes to gloss through these financial statements, but about an hour to present it in the very hurried form above. If I spent a couple extra hours, I could have really polished up the presentation, but this was enough for me. If you found this at all useful, please let me know.