Pengrowth and oil

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Monday May 16, 2016

A key component of our investing mantra is that we love to invest in sectors that are out of favour. That was the reason for our plays in oil and gas in 2014 and 2015, but like virtually everyone who dabbled in this arena, we have had our heads handed to us on a platter.

One company that Benj purchased in December of 2014 was Pengrowth Energy (PGF). This relatively old mare of the Calgary oil patch was founded in 1988 and, while apparently long on potential, it has fallen short on reward. If one looks at the chart, a stock that once crested $27 and paid a dividend of 25 cents a month is now trading at a couple of bucks. The dividend has been relegated to dinosaur status.

Pengrowth was one company in the oil patch that initially benefited from the creation of income trusts, which arrived on Canadian soil in 1985 with a tax ruling for the Enerplus Resources Fund Royalty Trust. That opened the door for a wave of companies to take advantage of the new regulatory environment with investment banks jumping in to fuel the feeding frenzy, as they saw a spectacular opportunity to garner huge fees. Alas, the party came to an end in spooky fashion on Halloween, 2006, when Jim Flaherty, then the federal finance minister, put in place a 34 percent tax on income trust distributions. Stock prices in this field immediately toppled.

We would argue that Pengrowth and many other companies in the income trust sphere were effectively recruiting shareholders to pay themselves in a Ponziish manner, as the corporations offered huge payouts without earnings to support them. No worries; more shares would be sold to cover the dividends. Of course, then more money would be needed to cover the diluted share counts and ultimately, in most cases, this was unsustainable. As in the case of Pengrowth, the dividend was chopped again and again, and this was taking place long before prices toppled for oil and gas.

Potential investors and those owners of Pengrowth who listened to the company’s quarterly conference calls extolling Pengrowth’s attributes might have assumed the company was doing very well. Meanwhile the share price continued to sink, hitting a bottom of 66 pennies in January of this year. At that point, it appeared that bankruptcy might be in the cards. The NYSE notified Pengrowth that it was in non-compliance as the share price had spent 30 days under a buck. A non-cash impairment charge of $519 million this past quarter “highlighted” a loss of $463 million.

However, the story might yet have a happy ending. Pengrowth replaced 282 percent of 2015 production. The Lindburgh project in Cold Lake, Alta., has been performing beautifully with production increasing swiftly and more to come. Debt has been reduced and refinanced. The hedging program has helped buffer the bottom line.

One gentleman who is bullish on this outfit is highly successful investor Seymour Schulich. Over the past few months he acquired 90 million shares, equal to 16.6 percent of the corporation. That is a mighty strong show of support. Evidently other investors have noticed as the stock price has jumped, while regaining compliance with NYSE regulations.

Benj’s initial sell target when Pengrowth was purchased at $4.16 was $15.44. While that might indeed be pie-in-the-skyish, double digits for this entity do not seem out of the question. However, consolidation in the oil patch might lead another producer to swoop in for Pengrowth before this price is beyond a whisper.

When the oil price was at its nadir, our supposition was that we would see, at minimum, a $50 (US) per-barrel price in West Texas intermediate crude before the end of 2017. Currently sitting above $47, achieving that appears as a likely possibility sooner rather than later. Above and beyond that level, achieving $70 would not surprise us and if that happens, people throwing their money into companies in this arena now should profit handsomely as long as they choose survivors. History has shown that this exceedingly cyclical sector rewards investors who are willing to plunk down money during the difficult times.