Parex Resources - still undervalued

But PXT.TO is a buyback failure despite its undervaluation

In the past four years, Parex (PXT.TO) has been the poster boy for the buyback craze, repurchasing for cancelation around one third of the shares outstanding. Instead of a rising share price, Parex shares have dropped 33% in the past 6 months.

The case for Parex’s buybacks was a strong one. The company trades at a miniscule price to cash flow, has a relatively clean balance sheet, and is a profitable operation. But despite over CAD$700 million in buybacks, the stock today trades at a lower price than 18 months ago and the shareholders who accepted the buybacks received the $700 million and, if they were energy investors, re-invested the money in the strong energy trade that has made many energy investors millions. Despite the solid evidence the shares of Parex remain deeply undervalued, I have avoided the stock owing to the political risk in its jurisdiction. Had I held the stock, I would have preferred to receive the approximately CAD$5 in dividends the money used for buybacks would have funded.

For patient investors who remained long Parex shares, this could work out well. For those who need income from their investments to pay their bills, betting on a company that is clearly undervalued and where the mathematics of the buybacks is far superior to a dividend model, the shares can still be a bad bet (as they have been in this case at least to date). Patient money remains likely to benefit from the buybacks and possibly in a material way. I estimate the company is worth about double its 2018 value and with 33% fewer shares outstanding than four years ago, if the share price trades at fair value longer term investors will have tripled their investment.

But there is an important caveat which is best described in the old adage “markets can stay irrational longer than you can stay solvent”. Commodity markets are cyclical and it is possible, even likely, that oil prices will fall materially in an expected recession. Should that happen, the time frame to realize a benefit from a Parex investment made in 2018 could easily run to 7 to 10 years, and if you borrowed money to buy your shares you have been playing “shell out” for quite awhile.

The point of this article is twofold. First, at its current trading price Parex is likely substantailly undervalued and a position in the company for longer term energy investors may prove rewarding. Finally, making investments based on the estimated benefit of a buyback strategy is a gamble, and even when the underlying thesis of undervaluation is correct, that gamble may still not pay off. That is why I prefer companies pay out free cash flow in dividends and let me decide how much risk to take.