|Shares Out. (in M):||131||P/E||0||0|
|Market Cap (in $M):||889||P/FCF||0||0|
|Net Debt (in $M):||852||EBIT||0||0|
|TEV (in $M):||1,740||TEV/EBIT||0||0|
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Paramount Resources is one of the oldest publicly-traded oil and gas companies with over 2 million net acres of land in Canada. The stock is trading at multi-year lows, and I believe has an expected return of between 200% and 300% in the next year. The most important catalyst should happen very soon: growth in Q2/19 from their new Wapiti field in Alberta. Given the age of the company (IPO in 1978), legacy field production is much lower than typical shale fields, and requires much less capital to sustain. With a lower declining base and new production from Wapiti, Paramount’s production should increase after a year of declining. To oversimplify: oil and gas stocks typically move higher when production is higher than expected. With Paramount’s stock near 20-year lows, and production about to start growing after a year of declining, the stock should have a strong tailwind towards realizing my price target of ~$20/share. I believe downside is limited (outside of macro oil price shocks), given how low expectations are.
Paramount has production from three regions, but for simplicity’s sake, only one of the regions matters to the upside valuation case. The three regions are: Grand Prairie (where the crown jewel assets of Karr and Wapiti reside), Kaybob Region (will likely decline 15-20% per year) and Central Alberta (will likely decline 10-15% per year). The most important region is Grand Prairie, which is currently 1/3rd of production, and consists of the Karr and Wapiti regions. Wells here have payback periods of approximately 15 months, making them amongst the top oil wells in North America. Paramount has drilled over thirty wells at Karr and has seen consistent results. The Wapiti region, which is right next door to Karr, just had their first wells turn online in April/May when Keyera’s gas processing facility came online. The main growth driver for Paramount will be Karr and Wapiti.
History and Why the Stock is Mispriced
Today’s investment opportunity exists because of what transpired in the last two years. In 2017, Paramount bought Apache’s assets in Canada. The crown jewel of Apache Canada was the Wapiti region in Alberta; however, production from Wapiti could not start growing until mid-2019 as Paramount had to wait for Keyera to finish building infrastructure in the region. This meant that 2018 should be uneventful year with no growth. Guidance in 2018 was set at flat production of 100kboepd. However, actual production came in at 86kboepd. Paramount’s stock fell, as most oil and gas stocks do when guidance is reduced.
The bear thesis on POU is simple: production went from 95kboepd in Q4/17 to 85kboepd in Q4/18 despite $600m of capex and management’s initial promise of 100kboped of production. Bears don’t believe management’s new 2019 guidance for growth to 85-90kboepd in Q4/19 with only $350m of capex. These are the primary reasons why the stock is priced near 20-year lows today.
The bridge from 95kbodp in Q4/17 to 85kboepd Q4/18 is as follows:
5kboepd less from an asset sale (Resthaven land)
~5kboepd less from disappointing results in their new Duvernay land (exploration region that didn’t work – guidance should have been set more conservatively).
~5kboepd less from various midstream and third party issues.
Expectations for 2019 production growth are therefore extremely low. I believe Paramount’s production will exit at nearly 100mboepd (guidance is for 85-90). My simple math is as follows:
Q4/18 production was ~27kboepd. This has been their best asset recently, and production was kept flat in 2018 (exit to exit) because of midstream constraints. The company expanded their infrastructure slightly in 2H/18 and I believe production could exit 2019 around 30kboepd.
The company had zero production here in Q4/18, but began turning online wells in May/April when the long awaited Keyera gas processing facility turned online. The company will have over 20 wells drilled and completed this year, and has guided to an average IP 365 of 1395 boepd. If you multiple 20 by 1395 you get nearly 28kboepd of incremental production averaged over the whole year. These wells start off at much higher rates initially, and not all 20 wells will be turned online immediately. I believe Wapiti could therefore exit 2019 producing ~20kboepd
This is a mature old field with a ~20% decline rate. The company is drilling a few new wells here, and I think production will decline 5% from Q4/18 of 37kboepd to 35kboepd in Q4/19
This is another mature old and gas field with a ~15% decline rate. I think production will therefore go from 20kboepd in Q4/18 to 17kboepd in Q4/19.
Summary Q4/19 estimate: Karr at 30, Wapiti at 20, Kaybob at 35 and Central Alberta at 20 = 105kboepd of production versus guidance of 85-90.
I believe 2019 guidance was set conservatively because a new investor relations team, which arrived later in 2018 after initial guidance was set, did not want to repeat the old team’s mistakes from last year.
Why will Wapiti results be good?
Paramount turned online their first wells at Wapiti in the 2nd quarter, and initial results should be released with Q2 earnings in August. Production could not start until Keyera finished building its gas processing plant in the region, which it did in the 2nd quarter of this year. Various operators with consistently good well results surround Paramount’s Wapiti region. Below is a map to show proximity:
Paramount’s Wapiti type curve shows the wells have payback periods of ~15 months and IRRs of 45% at $55 oil. Here are neighboring well results that give me confidence in Paramount’s Wapiti estimates:
Paramount’s Karr region: directly south of Wapiti and over 30 wells have been drilled here. Average returns are 64% with 18-month payouts.
NuVista’s Gold Creek acreage: directly west of Wapiti with 40% IRRs. Production in this region started in 2017 and so NuVista has plenty of well history underpinning its type curve.
Pipestone Energy’s acreage: directly north of Wapiti with 60% IRRs.
All IRRs referenced above assume a $55 WTI oil price.
Potential asset sales: Given the age of the company, Paramount has plenty of assets (both oil and gas acreage and infrastructure) that they could sell. Some analysts believe they could sell their infrastructure at Karr. Karr is currently Paramount’s best land (64% IRRs referenced above) and inventory life is substantial. Below is my math on Karr’s potential infrastructure value.
Upside: If Paramount exits 2019 at over 100kboepd, I estimate they could produce between 110 and 120kboepd in 2020. At $55 oil (WTI) and $5 condensate differentials, EBITDA would be ~$600m. (My EBITDA estimate is after paying their annual abandonment liability). Subtracting debt of $800m, and assuming 5x EBITDA, equity value is over $2.2bn and $17/share. Shares are at $6.8 today.
Downside: If we take 2019 EBITDA consensus of $350m (most sell side is bearish/neutral on the stock) and apply a low 4x multiple, after subtracting $800m of debt the valuation target becomes $4.60/share. Downside is therefore ~30%. I could imagine such downside scenario if Wapiti results are delayed for some reason (infrastructure constraints or operational problems that have plagued Paramount in the past).
Abandonment liability: Paramount has a ~$800m abandonment liability, which it pays out ~$30m per year. Recently in Alberta, the government ruled that in bankruptcy the abandonment liability of an oil and gas company becomes senior to bank debt. As such, some investors are concerned that Paramount’s large abandonment liability could cause its revolver size to be reduced and negatively impact the company’s liquidity. However, Paramount’s revolver does not mature until November of 2022. The company has drawn $800m on their $1.5bn revolver, and as such have plenty of liquidity in the interim. I think the company will have material free cash flow after 2020, and so the size of its revolver will become less relevant after 2022.
Guidance in 2019 is reduced – bears will point out that Paramount reduced guidance in 2018, and the company’s track record of executing against guidance isn’t good. If, for whatever reason, Paramount reduces 2019 guidance (because Wapiti wells are below type curve, or infrastructure issues creep up again), I think downside to the stock is 30%. Please see my valuation section above.
Oil/gas prices – this risk is common to any oil and gas company. One could hedge out these risks by shorting another oil and gas producer.
In the interest of full disclosure of potential conflicts, I work for a company that currently has a long position in Paramount Resources. The opinions presented here are my own and are based on my research alone, and are not necessarily those of my employer. There is no guarantee that the price targets I’ve modeled will be reached, and the share price could actually decrease depending on trading dynamics, company announcements, market conditions and other unknown factors.
Market does the math.
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