Only a few oil and gas companies actually provide meaningful growth and yield at the same time. While Crescent Point Energy stands out in the oil weighted universe, Peyto Exploration is its counterpart in natural gas. Having the lowest operating costs per mcf is one of a few factors that?make of Peyto one of the top pure-play natural gas producers in the Canadian energy sector.
Peyto Exploration operates exclusively in Alberta?s Deep Basin. The company assembled a drilling inventory of more than 1,100 net horizontal locations That?s more than 10 years of drilling at 2013?s pace (100 gross ? 85 net wells planned.) The company has been focused on the Deep Basin for over a decade and has developed a high level of expertise in the area?s geology ?(gives you an edge for picking out the best spots).
One of the primary reasons behind Peyto?s enviable position is the fact that their operating cost is the lowest in the industry: $1/mcfe (as of Q3). The company not only survived 2012?s record low natural gas prices, it continued to thrive. So far this year, PEY is on track to realize more than $3/mcf on its gas sales thanks to a strong hedging program.
Thats in stark contrast to YTD AECO pricing which has averaged $2.33 stressing numerous balance sheets of natural gas weighted producers.
While $3/mcf is by no means thrilling, ?it is significantly higher than this year?s average and sets the company up for a meaningful ramp up in cash flow should this winter turn out to be normal or better yet colder than normal. On top of hedging, the high heat content in Peytos produced gas fetches a premium pricing of about 15%?over AECO .
What helps the company realize the lowest cash costs mainly resides in its high ownership in land, infrastructure and natural gas processing facilities. When you own your own infrastructure, you are the master of your domain. Peyto:
- Operates 99% of its production
- Processes 95% of its production
- Owns 96% interest in 7 processing facilities
When it comes to growth, Peyto has so far delivered 35%/share YOY growth since inception. Q3 2012 production increased 27% YOY from Q3 2011. In 2013, the company is guiding for a 62,000 to 67,000 boed exit compared to 2012?s 57,000 boe/d exit rate. At the upper end of guidance, that?s a net increase of 18%.
Peyto PEY.TO 30.94 [+0.06] pays an annual $0.72 /share ? that?s less than 3% yield at the current price. I believe the low yield reflects the perception of a best in?class?natural gas producer. The stock enjoys a premium trading at a higher EV/BOED metric than peers with a higher oil weighting (compare to Enerplus Corp. for example). That?s despite an all in payout ratio above 100%! Let?s take a look at the dividend sustainability in 2013:
- 2013 average annual production at 62,000 boe/d (88% gas)
- 34% annual production decline * 57,000 exit production + 5,000 boed in new production
- That?s an estimated 25,000 boed, capital efficiencies of $17,500 brings the budget to ~$430M
- Capex at $500 million accounting for announced facility expansions
- Average realized natural gas price of $3.40/mcf AECO (based on PEY guidance)
- $74/barrel of oil/liquids (using YTD realized price)
Obviously, the price of natural gas is what counts here. Using the above scenario, the total payout ratio is estimated at 129% for a deficit of about $138 million in 2013. That amount can be absorbed as the company was less than 50% drawn on its $880 million credit line as of Q3 (accounting for the latest financing). As for the debt to cash flow ratio, it falls from 2.2x ?in Q3 (annualized funds flow) under 2.0x in 2013.
Peyto needs to realize $4.70/mcf in order to bring the total payout ratio below 100%. When, not if, export facilities kick in, the price of natural gas is expected to recover. Peyto will be able to double its dividend at $5.70/mcf and still remain below the 100% payout ratio (based on capex & production assumptions above). All that to say, the company is highly levered to the price of natural gas and will have the option to increase its dividend thanks to increasing cash flow.
It is important to remember that the figures above provide a snapshot of the company. If Peyto chooses to?defer?spending on infrastructure, these numbers will change as the capex will end up lower than $500 million. Each 1% shift in production weighting impacts the total payout ratio by a small number of percentage points. But most important of all is the realized price of natural gas which will have the last word for all figures.
Finally, Peyto is one of a few intermediate producers?successfully?executing a growth and yield strategy. It is a quality company that provides investors with an excellent vehicle to bet on rising natural gas prices. Of course, natural gas prices would be the biggest risk as low commodity pricing for an extended period of time can bring down the best of the breed (the hedges eventually?run out ). So far, the natural gas market looks to have stabilized with inventories trending lower towards the 5 year average. Its a promising start for a cold 2013 that should set a positive tone on the price of natural gas.
What do you think of PEYTO?