PEYUF - Peyto Exploration: A Large Natural Gas Producer To Consider

2023-05-21 11:45:00 ET

Summary

• Peyto Exploration is a large natural gas producer with a low production cost.
• Existing hedges and exposure to different markets are helping the company to boost its realized price.
• Peyto has a Reserve Life Index of about 24 years, making it a good vehicle to have exposure to the natural gas price.

Introduction

It has been a while since I last discussed Peyto Exploration & Development ( OTCPK:PEYUF ) ( PEY:CA ), but as I think it’s almost time to slowly reposition myself in natural gas players and gradually increase my exposure, I wanted to have a look under the hood. As Peyto recently published its Q1 results, it provided the market with an up to date representation of the current situation.

The damage remained limited in the first quarter

Peyto is a large producer. During the first quarter of the year, the company produced almost 103,000 barrels of oil-equivalent per day. That’s just a pro forma equivalent calculation as the company doesn’t produce any oil. As you can see below, the vast majority of the oil-equivalent production consists of natural gas (88% of the total production) with the remainder coming from natural gas liquids.

During the first quarter, Peyto reported an average realized price of C$3.91 for the natural gas (after taking hedging gains into account), which definitely helped the company’s Q1 performance as that’s a pretty strong realized natural gas price. As you can see below, the total revenue during the first quarter came in at C$254M but this includes a realized loss on hedges to the tune of about C$67M. Interestingly, Peyto only records realized gains and losses in its income statement. The unrealized gains and losses flow through the comprehensive income statement, and as you can see below, the existing hedge book created about C$193M in pre-tax value thanks to the decreasing natural gas price. This unrealized gain is not included in the reported income statement.

Going back to the reported income statement, Peyto still is a very low-cost producer. As you can see below, the combination of operating and transportation expenses is just over C$41M which is just a fraction of the reported revenue. This means the pre-tax income was C$118M (including the C$67M in realized hedging losses).

The net income was just under C$90M for an EPS of C$0.51 . Definitely a good result, but I also wanted to have a look at the company’s cash flows.

The total operating cash flow was C$183.6M which includes a C$3.8M working capital contribution and excludes the (small) lease payment. On an adjusted basis, the underlying operating cash flow was approximately C$179.5M.

The total capex was C$121.8M resulting in an underlying free cash flow result of almost C$58M. That’s indeed lower than the reported net income but that’s entirely caused by the big difference between the depreciation expenses (C$77M) and the total capex (almost C$122M).

This year’s capex plan calls for C$425-475M in spending (resulting in an average quarterly capex spending of approximately C$110-115M using the midpoint of the full-year guidance). This does include a production increase. Peyto refers to a 29% decline rate but it will be adding about 35-40,000 boe/day in production levels. This means the net production increase will be approximately 6-11,000 boe/day, and using the company’s anticipate capital intensity of C$12,000 per flowing barrel, this means there’s about C$75-140M in growth capex included in that number. That indeed means the underlying sustaining capex to keep the production flat at the current level of just over 100,000 boe/day is approximately C$350M. That’s less than C$90M per quarter, and applying that to the almost C$180M in adjusted operating cash flow, the underlying free cash flow would be around C$90M as well, for a free cash flow result of approximately C$0.50 per share.

Keep in mind that's based on the average realized natural gas price of C$3.91 in the first quarter of this year. The current spot prices are substantially lower. For this year, the company has no exposure to the AECO natural gas spot price (and this will continue until the second quarter of 2025).

Peyto has an extensive hedging policy, and this, combined with its ability to sell on other markets, has allowed the company to secure a higher realized price than the average AECO natural gas price in the past 15 years.

Investment thesis

While you may think Peyto’s realized natural gas price will decrease in the current quarter, it’s perhaps worth emphasizing the company’s hedges on the California market (the Malin selling point in Southern Oregon) have now concluded. Those hedges were locking in prices of just under US$3/mmbtu while the benchmark price for that market was almost US$20/mmbtu during the first quarter thanks to a temporary spike. This means that from the current quarter on about 6%-7% of the anticipated production will now have access to the market prices at the Malin delivery point, and Peyto made it clear it's planning to enter into hedging contracts when potential price spikes will occur.

I currently have no position in Peyto Exploration but I may add this to my list of natural gas producers I should perhaps start building a position in. The net debt position of C$830M doesn’t worry me and the reserve life based on the 2P reserves is approximately 24 years . As far as exposure to natural gas producers goes, Peyto Exploration and Development could be a good fit for my portfolio.

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