NAL Energy and Pengrowth Energy announced a strategic combination in an all-stock deal. NAL shareholders will receive 0.86 of a Pengrowth share for each share held providing them with a 26% ownership upon the closing of the deal. I analyzed NAL back in January where I explained why the company was going to underperform in 2012, besides a miracle in natural gas prices there was no way the share price was going to recover this year. This takeover is the only way for investors to make some of their money back since many of you like myself bought at higher prices in the good old days when NAL was trading above $10/share. Before you get blinded by the 20% increase in your dividends as a NAL shareholder, please continue reading to find out why, from my point of view, it’s not worth keeping those NAL shares.
The bombastic press release made it quite clear that the deal is accretive to Pengrowth. Good thing NAL’s CEO didn’t pull a SkyWest moment and call the deal “exciting”. The 9.7% premium we receive in many cases won’t help investors break even on the purchase price. From the combination news release:
The proposed business combination is expected to be accretive upon closing to Pengrowth shareholders on a funds from operation and production per share basis, and also provides NAL shareholders with a 20.4% increase in monthly dividends per share, an increase in reserves per share and exposure to a company with a longer reserve life index.
Of course, we did get a lollipop in the form of a 20.4% increase in monthly dividends. But before you get all excited, can the company afford this generous distribution? Let’s dig a little bit deeper into the new PGF. With 489M basic O/S, the company is guiding for 86,000-89,000 in average production with a $625M in capex and an exit rate between 96k-100k boe/d for 2012. Let’s take the mid-range of their guidance at 87,500 boe/d in average daily production with a 51% weighting to liquids. Using the following strip pricing for 2012 let’s see if the generous dividend is sustainable:
BTI Price Deck
- Canadian Par $95.00/bbl
- WCS Heavy Oil $80/bbl
- Liquids at $70/bbl
- Natural Gas at $2.50/mcf
Please take note that this is NOT a conservative price deck, Canadian PAR has averaged $95/bbl YTD and spot NG prices have averaged $2.17/mmcf YTD. There’s obviously downside risk to these prices. In fact, I am being generous with my NG pricing since the company has an insignificant amount of hedging for 2012 (<10%) and 0% hedged in 2013. Using these metrics the company will realize a cash flow netback < $23/boe. This translates into a total payout ratio of around 144% which is not to my liking at all. If we add the DRIP proceeds for a theoretical 60% participation rate, the total payout ratio drops to 110% which is still spending more than they’re making. That lollipop is too sour for my taste.
In the short term, the dividend distribution is not in danger; the company plans on raising money by selling 10% in non-core assets and enjoys a healthy line of credit. However, the excessive distribution is not the only thing I don’t like about PGF. Their recycle ratio for 2011 was a dismal 1.4 (the RR measures capital efficiency, how much do you generate for each dollar invested), not that NAL’s was any better.
The combination of the 2 companies grows an asset portfolio which in my opinion was already all over the place. Besides the Cardium land base, NAL’s portfolio is not complementary at all and just adds to the fragmentation. Furthermore, PGF seems focused on their Lindbergh SAGD Oil Sands project which is expected to grow production from 1,000 bopd in 2012 to 12,500 bopd in 2015 (take note of cost overrun + timing risks). Personally, if I wanted to invest in the oil sands, I would pick an integrated senior producer like Suncor. This focus on Lindbergh tells me PGF picked up NAL’s cash flow to fund its excessive dividend and its oil sands project which in both cases are a turn off for me.
It will take PGF a few years to grow its liquids weighting which is another reason I prefer smaller companies. Junior and intermediate producers are more flexible with their capital spending because impact on the production mix shows up relatively faster. Furthermore, PGF is an ex-trust used to increasing production through acquisitions rather than organic growth. Personally, there’s no reason to dig deeper, PGF is not compatible with my portfolio which is why I have decided to sell and move on.
What is your decision and why?