PARXF - Parex Resources: Trading At 3X Earnings The Risk/Reward Ratio Looks Appealing

• Parex Resources is a Canadian oil and gas producer with activities in Colombia.
• The company is ramping up production to end the year with an increase of about 20%.
• The newly elected president in Colombia has yet to unveil a proposed policy change, and that's holding the stock back.
• While there is some uncertainty, Parex is trading at just 3X earnings with about 20% of its market cap in net cash on the balance sheet.

Introduction

Although most oil producers are no longer trading at their 52-week highs, the current oil price of around $100/barrel still provides plenty of opportunity to generate very substantial cash flows. Parex Resources ( OTCPK:PARXF ) is a Canadian company focusing on its oil production in Colombia. The cash flows are phenomenal but the recent political evolution makes investors a bit reluctant to invest in the Colombian oil space.

Parex Resources is a Canadian company and has its primary listing in Canada where it’s trading with PXT as its ticker symbol . The trading volume in Canada is superior to the volume on the secondary listings as the average daily volume exceeds 600,000 shares per day. There currently are 116M shares outstanding (as the company has been aggressively repurchasing its own shares ), resulting in a market capitalization of just over C$2.55B (US$2.1B). As Parex reports in US Dollar, I will use the USD as base currency throughout this article unless indicated otherwise.

A strong first quarter of the year will provide the perfect setup for the Q2 results

Of course the first quarter is already four months behind us, but I think it still makes sense to have a look back at the Q1 results as this will allow us to extrapolate the performance and set some expectations for the second quarter.

In the first quarter, the company produced just under 51,700 barrels of oil-equivalent per day of which about 49,500 barrels were effectively oil. The oil was sold at an average price of US$86/barrel which was derived from an average Brent oil price of almost $98/barrel. Subsequently there are discounts based on the Vasconia differential and the wellhead sales discount. Additionally, there is a discount to the Brent oil price while an additional $2.99/barrel was required to cover the transportation expenses.

When all the dust has settled, the effective realized price was approximately $72/barrel or $75/barrel excluding the transportation expenses.

The total revenue came in at US$331M and this already includes in excess of $80M in royalty payments. And as you can see below, the production and transportation costs are still very low and this confirms Parex as a low-cost oil producer.

With a pre-tax income of $210M and a total tax pressure of approximately $55.5M, the net income was $152.7M. This works out to $1.29/share and if you’d convert that to Canadian Dollars, the free cash flow per share would have come in at around C$1.65-1.66 in the first quarter. Also keep in mind the EPS is based on the average share count of in excess of 118M shares. If I would use the ‘absolute’ share count as of the end of Q1, the FCFPS would have come in at around C$1.68. On an annualized basis, that’s in excess of C$6.5/share which makes the current share price look quite attractive.

What’s holding the stock back? A new president and a rather capex heavy year

Of course, there are a few elements explaining why Parex is trading at less than 4 times its earnings at $100 oil. The most important one is the outcome of the recent presidential elections in Colombia. The leftist Petro won the elections and he ran on an anti-fossil fuel campaign. We will have to see what this means for drill permits and production permits going forward (and I don’t expect suddenly everything to come to a standstill), but it does increase the geopolitical risk of running an oil company in Colombia.

The election was less than a month ago, so no new policy has been put in place but it for sure is an element the market will want to get some reassurance on. A recent article by Junius , published about 10 days after the election, paints an excellent picture of the current situation and why we shouldn’t worry too much at this point.

In Parex’s case, the leftist win coincides with what is the first year in a long time the company is aggressively spending cash on exploration and development to ramp up production. After spending just $141M in capex in 2020 and less than $275M in 2021, this year’s capex program consists of $550M in investments, so that’s a major step up. The $550M also represents about 4 times the annualized depreciation expenses, so Parex is definitely focusing on growth. We will see the results of this expansion program by the end of this year: Parex plans to achieve an average production rate of 54,000-56,000 boe/day (about 8% higher than in Q1 and Q2) with an exit production rate of in excess of 60,000 boe/day, which would be a production rate increase of almost 20%.

The massive investment plans don’t mean Parex will have to tap into its cash reserves. As the image below shows, the operating cash flow before changes in the working capital position was approximately $205M. That’s $820M on an annualized basis. If we would expect the Q2 operating cash flow to increase by 10% on the back of a higher oil price, almost $450M of the $550M plan will already have been funded by the incoming cash flow.

So funding the growth is not an issue at all (as the calculation above excludes the anticipated production growth in the second half of the year) and according to Parex’s capital allocation framework it is still expecting to spend $80M on dividends and $265M on a share buyback .

Parex spent $97M on share buybacks in the first quarter so it still has in excess of C$200M to spend (excluding the shares that have been repurchased between March 31 ^st and now - Parex announced it has already repurchased 7.2M on a YTD basis) which would allow the company to buy back an additional 8-9M shares at the current share price. That means the company could beat its forecasted outstanding share count of 110M shares by the end of this year. But that obviously will depend on the oil price in the second semester.

Investment thesis

While the geopolitical risks have increased until we see a clear policy from the new Colombian president actually being executed, Parex appears to be too cheap. Trading at a market cap of around C$2.4B (assuming a share count of 110M shares by the end of this year) the EPS at $100 oil will likely come in around C$7. This means Parex is trading at just around three times its earnings while the balance sheet contains in excess of C$4/share in cash.

That makes Parex attractive again from a risk/reward point of view. Mind you, the company will continue to trade at a discount to Western peers until Colombia makes it clear how it wants to deal with the oil and gas sector, so there are some risks. But the upside potential is very real.

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