Canadian Finance and Economics
Volatility (VIX) has gone under 30% for the first time since the whole mini-meltdown in August occurred.
I’m still remaining very cautious. I have not been in a very literate or concentrative mode over the past few days and thus whenever I have found myself in that situation, do not make investment decisions.
I hate being a chart reader, but the markets are forcing everybody to be one since nobody knows what is going on – inflation or deflation? Recession or not? Euro-default or not?
A couple prevalent charts with trend lines (very crudely drawn) indicated:
S&P 500:
10-year Treasury Bond:
Unquestionably there is a lot of concern out there with the welfare of the global economy – perhaps ECRI’s recession call was one more spike in the coffin. However, at this time, buying (or going short treasuries) is the most difficult thing to do – and a trader always knows that the best trades are the ones most difficult to do.
Sadly we are all armchair macroeconomists at this point. However, I have been compiling a “hit list” of securities that have gotten hammered over the past month and am somewhat hoping that there is another plunge down – ideally deploying cash at the time nobody else wants to. While the debt situation in Europe is hardly resolved, the potential impact of a credit freeze is being priced in with these huge and volatile price swings that go up and down.
Petrobakken (TSX: PBN) gave a quarterly status update with respect to its production and indeed, it is around what it stated (43,000 barrels of oil equivalent per day).
Most interestingly is the paragraphs they devoted towards recent speculation concerning their debt levels, with me bold-facing some of the quoted material below for emphasis:
At the end of September, PetroBakken had $1.14 billion drawn (essentially unchanged from the end of June 2011) on our three year, $1.35 billion credit facility, leaving us with over $200 million of credit capacity available on the current line in addition to our growing cash flow. Recently, there has been some market focus on our convertible debentures which mature in February 2016. The debentures have a one-time, one-day early put option on February 8, 2013 that allows those holders that elect to exercise the option to request payment in full for their debentures. In the event that holders request payment, PetroBakken has the option to repay in cash or through the issuance of PetroBakken shares based on the then current share price.
The Company has been, and will continue to be, pursuing various options to provide additional flexibility in order to repay any bonds that may be put back to us with either cash or shares. In addition to our growing production base and the potential for increasing cash flow over time, those options include: modifying our capital program and/or altering our dividend to provide additional free cash flow; issuing additional debt instruments; instituting a dividend reinvestment program; renegotiating the terms of the existing convertible debentures; or realizing on asset sales. Early in the second quarter of 2011, the Company engaged TD Securities Inc. as financial advisor, to assist the Company in our assessment and pursuit of certain options to provide increased liquidity, and we continue to actively evaluate alternatives going forward. Further announcements on the progress of this process will be made at the appropriate time.
We have positioned our asset base to focus on value creation for our shareholders, and decisions on how best to manage the business are made with both a short term and long term strategic outlook in mind. PetroBakken has built a strong portfolio of assets with a multi-year inventory of light oil drilling locations from which we can generate accretive, long term, growth. This portfolio includes over 440,000 net acres with over 1,400 net drilling locations in the well established Bakken and Cardium light oil resource plays; more than 480,000 net undeveloped acres and 300 light oil net drilling locations for conventional opportunities in southeast Saskatchewan; over 120,000 net undeveloped acres on new potential light oil resource plays (many that have seen significant attention by the industry in recent land sales); and a material land position in northeast British Columbia for future natural gas opportunities. With this asset base, and based on our current activity plans, we intend to deliver year-end 2011 production of 46,000 to 49,000 boepd. At the mid-point of this range, and based on US$85 WTI per barrel, we would expect to generate annualized cash flow of approximately $850 million. With expected continued growth in production in 2012, we would anticipate funds flow from operations (based on a similar WTI price) to grow further to equal or exceed our total capital expenditures and dividend payments. However, if conditions change, we will not hesitate to evaluate the other alternatives available to us, including altering our dividend and/or capital spending levels.
Current economic conditions and market rumours have caused shareholder focus to be turned away from the high quality, light oil assets that underpin the Company, to the perceived strength of our balance sheet in light of the convertible debenture put date (that is 16 months away) and our current capital and dividend plans. We are aware of the concern over our debt position and, as outlined above, we have several options at our disposal which we are actively assessing to effectively manage this situation in varying commodity price environments while continuing to pursue our strategies for long term, accretive, growth.
Some notes that went through my head:
1. The company’s current market capitalization is CAD$1.26 billion; the amount of the convertible note is US$750M. At present prices a share conversion would result in a 38% dilution of shareholder interest in the company. In addition, the additional amount of shares would virtually guarantee a dividend decrease (the convertible note’s coupon is 3.125%).
2. How much in capital expenditures does it take to sustain a production level at 43,000 boepd, or even to expand it to 46,000-49,000 boepd? If the company decided to pare back capital expenditures, how fast would production decrease? The large problem with the wells the company is producing is that the majority of oil obtained comes from the first year – production tapers off rapidly from the initial production.
3. Is WTIC at US$85 a valid assumption? Obviously this is something the company can’t control but is an obvious factor in the market price. At 47,500 boepd, WTIC at US$85 for CAD$850M operating cash flow will drop significantly as WTIC goes lower (more than a CAD$10M decrease to a US$1 drop in WTIC!). The operating cash flow is ultimately an incomplete figure since it goes back to question #2 where you have to ask yourself how much in capital expenditures will it take to actually keep production at that level. However, they do have 8000 boepd (roughly 17% of expected production) hedged with an average floor of US$76.09 WTIC in the year 2012. This still will not protect them from more significant decreases in oil prices.
I still believe Petrobakken equity is trading above fair value. They will be going through a painful de-leveraging as they figure out how to cough up US$750 million in 16 months.
While I have been losing a small amount of money on Yellow Media’s preferred shares jaunt to zero, fortunately I have steered far away from Petrobakken (TSX: PBN) which I have written here many times before.
They will not have an easy time renewing their credit facility which expires on June 3, 2012. The debtors are clearly in control of this one, just like how they are in control of Yellow Media. There is $1.14 billion in bank debt at the June 30, 2011 quarterly report. Another looming timeline is a US$750M debenture which holders have a put right – they give notice in December 2012 and the company must redeem at February 8, 2013.
(Update, September 29, 2011: Apparently they managed to renew their credit facility with an extra $150M in the facility… oops! This was announced in their Q2 financial update, which completely escaped me – this kind of blows a hole in the immediacy of cutting the dividend in the subsequent analysis, but there still remains a significant debt renewal of US$750M that will be taking place in February 2013).
From the MD&A, August 9, 2011:
As at June 30, 2011, PetroBakken had $1.14 billion of bank debt drawn on our $1.35 billion credit facility. Our credit facility is with a syndicate of banks and has a maturity date of June 2, 2014. The amount of the facility is based on, among other things, reserves, results from operations, current and forecasted commodity prices and the current economic environment. The credit facility provides that advances may be made by way of direct advances, banker’s acceptances, or standby letters of credit/guarantees. Direct advances bear interest at the bank’s prime lending rate plus an applicable margin for Canadian dollar advances, and at the bank’s US base rate plus an applicable margin for US dollar advances. The applicable margin charged by the bank is based on a sliding scale ratio of PetroBakken’s debt to earnings before interest, taxes, depletion, depreciation and amortization (“EBITDA”). The facility is secured by a $2.0 billion demand debenture and a securities pledge on the Company’s assets. The credit facility has financial covenants that limit the ratio of secured debt to EBITDA to 3:1, limit the ratio of total debt (total debt defined as facility debt plus the value of outstanding debentures in Canadian dollars) to EBITDA to 4:1, and limit secured debt to 50% of total liabilities plus total equity. The Company is in compliance with all of these covenants.
The TTM EBITDA is $659M, thus they are comfortably in compliance with this ratio. You would think the banks would be slightly uncomfortable with lending this much money in a company that is so heavy on capital expenditures.
My immediate guess is that the company will have to seriously curtail, if not outright suspend their dividend until such a time they are able to repay a substantial portion of their credit facility. This is not news to me – I had predicted this in May of 2011.
Another course of action they will likely implement is a slowdown of their capital expenditures. The only consequence of this, however, is that they will not be able to keep up their production levels, which their wells strongly taper off after the first year of drilling. This in turn will hinder their financial results.
The company is also highly sensitive to the price of oil and the past six months of WTIC trading has not helped their cause any.
Even though PBN has been sent down over 50% over the past couple months, it is still trading above my fair value.
As I alluded to in an earlier post, catching plunging knives (in this case, catching plunging share prices) will leave your hands bloodied, and indeed this has been the case with Yellow Media.
They announced this morning that they will be suspending their common share dividend and also will be reducing the size of their credit facility to $500M, of which $250M will be paid off at $25M/year from the beginning of 2012 onwards.
This caused their common stock to plummet, but oddly enough, caused their preferred shares to drop equivalently, to the tune of 50%.
PR.C shares are down to $3/share, while PR.D shares are down to $3.08/share.
By slashing the common dividend, they will save about $77M/year in cash flow.
With the common share dividend gone, it will remain an interesting decision whether the company will decide to cut preferred share dividends. PR.A will cost the company $10.7M/year, but this will be alleviated when they convert them to shares in April 2012. PR.B will cost $7.6M/year, but this will also be alleviated when the company force converts them in July 2012.
PR.C is the next drain on cashflow – $13.2M/year, and PR.D is $8.5M/year. Both of these series are cumulative and can only be called by the company at par ($25) which is obviously not going to be happening with them trading at $3 over the open market.
The debentures are trading at 32 cents and represents a $13M/year interest expense for the company – these interest payments must be maintained otherwise it will constitute a default – a 20% current yield, but how long will you see those coupon payments being paid?
The real question is: how quickly is the company’s cash flow diminishing? This “decay rate” is the critical variable in determining how financially viable the company is going forward.
The company’s preferred shares are obviously a very high risk and high reward type situation if your assumption is that they are not going bankrupt and they will be able to level off their cash flows at a positive amount.