Paramount Resources (OTCPK:PRMRF) operates a little bit differently from many oil and gas operators. This management generally packages its leases into saleable groups. From time to time, these sales generate significant income in addition to operations. Currently, this management purchased what was Apache Canada from Apache (APA). The massive project involved whipping all of the various holdings into reasonable competitive shape.
Source: Seeking Alpha Website April 10, 2020
Note: This stock is listed on the Toronto Stock Exchange under the symbol POU (TSX:POU). Liquidity may be better there than it is on the over-the-counter market in the United States. In any event, patience and limit orders as well as a stop loss strategy are recommended. This company has 133 million shares outstanding. Should liquidity dry up in the over the counter market, most brokers can access the Toronto Exchange for more liquidity.
Anyone with any idea as to how massive Apache Canada was knew this project would take awhile. The stock price above shows that Mr. Market lost interest in this reclamation project. However, management has been fixing and selling various pieces of the acquisition to finance the “areas of interest” from the acquisition. Cash flow has been increasing rapidly as a result. Long-term debt will vary depending upon where management is with each of the improvement projects. However, the goal at the end of the project will be to have a saleable interest that others would love to buy enough to bid up the sales price.
The latest coronavirus scare appears to put sales on hold. For this management, a delay in selling some parcels does not really harm the long-term prospects of this optimization project.
Management has decided to lower the budget to accommodate the lower industry prices. Offsetting this is a steadily rising percentage of liquids production. Management has also instituted a superior marketing strategy for natural gas produced to obtain better natural gas pricing.
Far more importantly, the Canadian oil and gas industry is relatively idle during Spring Breakup. That seasonal period is now upon us and most of the industry does not begin any material activity until the third quarter. Therefore, the announcement above has very little practical effect because much of operations as now are doing maintenance for a few months. Generally, Canadian companies re-adjust their capital budgets depending upon industry conditions when activity effectively restarts in the second half of the fiscal year.
While cash flow and earnings are improving, they will fluctuate as the various projects progress. In addition, management maintains shareholdings in various companies. From time to time, management makes the decision to sell some of these holdings or to merge with the smaller company. In some ways, this company operates more like a mutual fund of projects and company holdings rather than a growing oil company.
(Canadian Dollars Unless Otherwise Stated)
Source: Paramount Resources Fourth Quarter 2019, Earnings Press Release
As shown above, the adjusted funds flow more than doubled the figure for the previous year. If that funds flow figure is annualized, then the adjusted funds flow would be C$374 million. That means that net debt is less than 2 times the annualized 4th quarter cash flow.
Therefore, this company is going into the coronavirus situation with relatively decent leverage ratios. The weak Canadian dollar also helps profitability as this company markets its gas to the United States. So it receives United States dollars for some of its revenue and pays for expenses in Canadian dollars. Furthermore, the condensate produced is sorely needed in Canada. During normal times, that condensate generally sells for a premium to the price of oil.
Source: Paramount Resources March 19, 2020, Investor Presentation
The company has in place a decent hedging program. Evidently, the condensate was not hedged, so the company will feel the full effect of that pricing decline for as long as it lasts. As noted above, the rapid increase in cash flow until the coronavirus hit provides considerable downside protection. This company had a netback-to-revenue margin of nearly 40%. Therefore, the hedging should allow for some decent cash flow in the first quarter despite current pricing weakness.
The big question will be how long the coronavirus challenges last and the speed of the recovery. That condensate is used to make thermal and heavy oil flow through the pipelines. Traditionally, Canada imports about half its condensate needs. But the production cutbacks and the record low pricing for heavy oil and thermal oil will change that dramatically until the recovery begins.
In the meantime, this company has a decent credit line with more than sufficient ability to loan money. A company with the ratios posted in the fourth quarter will most likely be allowed a covenant variance or two in a situation like this.
What may be materially delayed is the periodic sale of some parcels to finance the development and renovations of more of the (formerly) Apache Canada properties. What will not be delayed is the shift to higher valued production areas while the company lives within cash flow. That will probably mean that the percentage of liquids production will continue to rise (Apache Canada produced nearly all natural gas at the time of the purchase by Paramount Resources) even though drilling is reduced. Investors will see the benefit of this during the recovery.
Most importantly, this management saw the potential for liquids production from the acquired acreage. As management has assigned priorities and rearranged operations for improved profitability, the liquids production has steadily increased. Management may well be able to improve things more in the future.
Condensate is a particularly valuable commodity in Canada. In fact, the right kinds of condensate often sell for a premium to the price of oil. That is particularly important when oil prices are low as they are currently. Canada has often imported the necessary condensate because it does not produce enough to mix with the heavy oil and thermal oil produced. The mixing is necessary to get the oil to flow through pipelines to the seller or for export.
During the coronavirus challenges, some of these (Apache Canada) issues may be hidden by the rapid demand decline. But the recovery of earnings could be unexpectedly strong as management continues to make progress during this time of pricing weakness.
Current Projects And Objectives
Canada is actually in a slightly different situation than the United States. The Canadian dollar is weaker so these companies can get by with lower prices than their United States counterparts working with a stronger dollar. Plus AECO actually crashed in the past. No matter what happens now, AECO is unlikely to surpass those past lows. The recovery may be bumpy thanks to the coronavirus. But this industry is actually already on the way back up.
Source: Paramount Resources March 2020, Shareholder Presentation
As shown above, management originally envisioned a busy fiscal year. Generally the activity is winding down in preparation for Spring Breakup. So the current coronavirus delay announcements and budget reductions fit right in with the typical seasonal plans.
Historically, things like the coronavirus bug tend to pass quickly while doing minimal long-term damage. This latest bug may not pass through quite as quickly. However, the chances of governments finding a way to get all of us back to work soon are excellent. The effects of this bug have yet to really be completely determined. If an investor happens to think (or news comes out) to determine that the coronavirus will be a long and economically significant event, then this investment may not be the way to go.
In any event, much of the Canadian industry begins to revert to repairs and maintenance with minimal drilling or fracking until the Spring Breakup is complete. The Canadian industry is in the position of having a natural activity break right when the coronavirus challenges appear to peak. The Canadian industry has the luxury to determine when and how much activity to plan when drilling restarts seasonally in a few months. At that point, both the coronavirus and the oil price war should have far more certain effects and forecasts than at the current time. Therefore, capital budgets are much more flexible for this Canadian company than for the American counterparts. Management can literally elect to not begin drilling until the beginning of the next fiscal year.
This company entered the current situation with adequate finances. Debt was a little more than twice the cash flow of the previous year and that cash flow had increased considerably over the current year. More capital projects were in place to decrease costs still more and provide enhanced flexibility to increase production in a low-cost fashion.
This company has also augmented cash flow by buying and selling properties as it whips the current purchase into shape. Management has recouped the purchase price through sales while retaining much of the production. That is the sign of a bargain purchase. Clearly, a lot more needs to be done.
Canadian banks view things a little differently than United States banks. For example, I followed Baytex Energy (BTE) as the long-term debt-to-cash flow ratio soared as heavy oil profits evaporated. Similarly, the first article on Paramount Resources saw even higher debt relative to cash flow. Then management sold the properties for a huge gain a few months later to purchase what was then Apache Canada.
The banks in Canada generally work with producers during a downturn like the current one. That is especially true for a company like Paramount Resources that packages parcels and then sells them for profits in addition to the usual cash flow sources.
There is plenty of potential liquidity as long as management is able to operate as it has in the past. The current headlines will probably fade within a few months to something a little less paralyzing. Property sales may be delayed and the capital budget could be reduced. It also depends upon the current evaluation of the oil and gas market. In any event, this company appears to have the resources necessary to get through the oil price war.
The significant gas production is definitely an advantage. Natural gas pricing is likely to strengthen now that large chunks of the industry are either not drilling or drilling simply to maintain leases. The Canadian gas producers are actually recovering from their own disastrous AECO pricing in the recent past. Therefore, current pricing is actually better now.
When Apache Canada was purchased, the gas was not hedged, there were no long-term contracts, and the natural gas was sold to AECO. Needless to say, this asset was not making a lot of money. The marketing has greatly strengthened the average price from the initial stages as AECO pricing is only received for a small amount of natural gas produced.
Source: Paramount Resources March 2020, Shareholder Presentation
This company has liquid investments in other companies. These holdings could be a source of business combinations to strengthen the company and enhance its chances of surviving the current industry challenges if that becomes necessary. There is also the possibility that some of these holdings could go public to raise cash or be sold.
The current headlines of the coronavirus and the oil price war are unlikely to affect this company as much as some others in the industry. Like many in the industry, this company has hedged and has some contracts to commit to known natural gas pricing for the fiscal year. Unless this crisis lasts more than about 9 months, this company should be able to meet its long-term profitability goals with minimal delays.
Cash flow is likely to drop from fourth-quarter levels in the first and second quarters. After that, the effects of the current situation are less clear. The risk is the severity and duration of effects from the current industry situation.
Financial strength and liquidity appear adequate. A little less debt would be more satisfactory during the current industry challenges. But the situation appears manageable.
This management has a long history of buying and selling assets as well as improving asset operations. Therefore, the Apache purchase is likely to reward shareholders a lot in the long term. Periodically, this company sells part of the operation for a big gain. So earnings here can come in lumps.
In the meantime, there is the coronavirus. That challenge is likely to delay some plans but probably will not dent long-term profitability and prospects. Like many in the industry, this fairly cheap common stock is worth consideration.
This stock is listed on the Toronto Stock Exchange under the symbol POU (TSX:POU). Liquidity may be better there than it is on the over-the-counter market in the United States. In any event patience and limit orders as well as a stop loss strategy are recommended.
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Disclosure: I am/we are long PRMRF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.