Peyto Exploration record quarter impresses

Would be even more impressive but for $53 million hedging losses

Peyto Exploration (PEY.TO) has long been a favorite of mine owing to its low cost operations and strong management team led by Darren Gee. While Peyto continues to carry CAD$1 billion in debt, operating cash flows are now in the CAD$1 billion range and many investors are confident debt levels will fall materially this year.

Burdened by ill-times “hedges” Peyto made the wise decision to increase output, averaging the hedging losses over more production and taking advantage of the currently strong prices to pump up cash flows to what is for the time being a record level. Investors with short memories may forget that Peyto stock traded higher than CAD$40 per share in 2014.

Looking throught the unfortunate hedges, a rough valuation of Peyto based on a run-rate of CAD$1 billion in EBITDA and a 4X multiple of EBITDA gives a value of CAD$18 a share adjustedf for the CAD$1 billion debt still on the balance sheet. As that debt falls away by an estimated CAD$325 million this year, the share value rises to CAD$20 a share. By the end of 2023, Peyto may well be debt free if today’s firm commodity prices persist.

I held 10,000 Peyto shares when I last wrote about the company and concluded then it had speculative appeal despite its debt. Since that time I added May 2022 options at strike prices of CAD$10.50 and CAD$13.50 and will likely exercise those options when they mature in 10 days time. While I remain concerned about the debt level and don’t like the “hedge” book, I am reasonably confident natural gas prices will remain firm and debt will fall away, and consider the stock a businessman’s risk. If Peyto ceases its incessant hedging and gets it debt down below CAD$500 million, I will add to my holdings for the long term.