Peyto Exploration will report a strong fourth quarter
2022 Guidance will evidence the earnings power of this low cost producer
I have long been a fan of Peyto Exploration and Development (PEY.TO), one of the lowest cost producers of natural gas in the Western Canadian Sedimentary Basin. I purchased some Peyto shares at $1.14 a share and built a position of 55,000 shares, but when the stock soared I sold my position down to my current 10,000 share holding. By any objective account, I sold too early despite racking up very substantial gains.
Natural gas prices in North America have been far stronger this year than last. In the fourth quarter of 2020, Peyto turned in cash flow of $76 million realizing oil and liquids prices of $35.82 a barrel and natural gas prices (net of hedging losses) of $2.19 per thousand cubic feet. In the fourth quarter of 2021, I estimate Peyto’s oil and liquids enjoyed a price of about $40 per barrel and natural gas sales (including the 15% heat content premium Peyto’s natural gas commands) about $3.75 a thousand cubic feet. Production has also risen year over year, with fourth quarter 2021 output approximately 100,000 Boe/day compared to about 84,000 Boe/day in 2020.
Based on those assumptions, I believe Peyto will report cash flow before interest charges and dividends of over $180 million for the final 2021 quarter, and guide to even better results for the first quarter of 2022.
At year end 2020, Peyto stock was trading at about $3.90 per share and today those shares trade at $9.40. The market is recognizing the improved financial picture but continues to undervalue Peyto shares in my opinion. A rough indication of value is to capitalize 2022 cash flows of at least $720 million at five times for an enterprise value of $3.6 billion, subtract $1.1 billion of debt, and divide the result by the 165 million shares outstanding, which gives an indicative share price of about $15.00. That approach is sensible but ignores a hidden asset - Peyto owns its own infrastructure which contributes to its low costs but has a market value in excess of the added cash flow arising from those low costs.
I estimate owning its own infrastructure saves Peyto about $0.20 to $0.40 per thousand cubic feet of gas versus purchasing processing costs from third parties. That saving comprises about $50 to $100 million per year which amounts to as much as $500 million of Peyto’s market value at a five times multiple. But the owned infrastructure had a first cost of over $6 billion and in my view has a market value of at least $1 billion. The “hidden value” increment of some $500 million equates to another $3.00 per Peyto share.
Peyto reinstituted dividends at a monthly rate of $0.05 late last year and now has a yield in excess of 6%. Despite the payout, cash flows fully fund the capital program, dividend payments and leave a surplus which is applied to repayment of debt. I expect Peyto to pay down debt of at least $200 million in 2022 and to keep repaying debt until it reaches a nominal amount.
I hold my Peyto shares in a tax free registered account and benefit from the absence of taxation on both dividends and ultimately capital gains should I decide to dispose of the shares. I do see the $1 billion debt as an issue and will keep a close watch on Peyto’s progress in reducing its debt to where it poses no risks even with a collapse in commodity prices. In the meantime, I think the shares are undervalued and have speculative appeal.
All dollar figures in this article are Canadian funds.