Introduction

In the most recent joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits a subscriber asked about Conservative Portfolio holding Peyto Exploration & Development (TSX: PEY, OTC: PEYUF). Here was the question:

“Robert published a table showing standard measure, EBITDA and other parameters for US energy companies. Could you please give those values for Peyto as well?”

I have spent a lot of time lately discussing oil prices and oil producers, but not nearly as much talking about natural gas producers, and how they have fared amid the continuing weakness in the energy markets. I will be addressing that over the next two issues. Today I want to provide some metrics for Peyto and other Canadian drillers.

First, a little background on Peyto. Over the course of the three years I have been doing these web chats, I have been frequently asked about Peyto. The stock’s long-term performance has been extremely impressive, but I wasn’t deeply familiar with this Canadian natural gas producer.

We finally added Peyto to the Conservative portfolio in November. (See “A Canadian Keeper With Startling Returns.”) The stock has lost 12.9% since, faring better than the broader energy market and most other natural gas producers.

Returning to the question, in a previous issue I looked at the U.S. oil and natural gas producers. (See “Delta Force.”) I was evaluating the companies that were making the biggest strides toward positive free cash flow (FCF) in this challenging market. In the process I looked at important financial metrics like the standard measure, which represents the present value of the future cash flows from proved reserves as of year-end 2014.

The standard measure is a requirement of the U.S. Securities and Exchange Commission for stocks traded on major domestic exchanges. Peyto trades on the Toronto stock exchange, and over the counter in the U.S. As a result, it doesn’t have to report a standard measure. Peyto does report a PV10, which is closely related to the standard measure but is a non-GAAP financial measure. Different companies calculate the PV10 in different ways, in contrast to the standard measure.

We can still evaluate important metrics for Canadian companies, and we can even compare them to U.S. companies. But the comparisons won’t quite be apples to apples because of the differences in tax law and other regulations, So let’s start by looking at Canadian gas companies like Peyto.

There are 94 oil and gas companies that trade on the Toronto Stock Exchange (TSX) and another 234 that trade on the TSX Venture Exchange (TSXV). The TSXV is for smaller capitalization companies that don’t satisfy TSX requirements. I limited this screen to companies with an enterprise value (EV) above $500 million (U.S.) and proved reserves at the end of 2014 of at least 70 million barrels of oil equivalent (BOE).

This screen identified 27 Canadian companies meeting these criteria, all of them listed on the TSX. (By comparison, 64 companies trading on U.S. stock exchanges met these criteria.) I further split this list between oil and gas producers, depending on the percentage of proved reserves in the gas category. Those with gas constituting more than 50% of proved reserves were classified as gas producers (even though in some cases oil contributed more of their revenue). That split the Canadian list into 13 oil companies and 14 gas companies, including Peyto. First, here are the gas producers sorted in descending order by EV, along with some important valuation metrics:

• EV = Enterprise value in millions of U.S. dollars as of Sept. 11
• EBITDA = Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in millions of U.S. dollars
• Debt/EBITDA = Net debt at the end of the most recent quarter divided by TTM EBITDA
• FCF = Levered Free Cash Flow for the most recent fiscal quarter in millions
• Res = Proved reserves in million barrels of oil equivalents (BOE) at year-end 2014
• R/P = Year end 2014 reserves divided by 2014 production
• Int/Rev = Interest paid in the most recent quarter as a percentage of revenue
• CR = Current ratio (current assets divided by current liabilities)
• Gas = Natural gas as percentage of proved reserves at year end 2014

Because the standard measure isn’t calculated for most of these companies, I added some other metrics of interest. While regular readers will recognize most of them from previous discussions, there are two new ones that I will mention. The R/P ratio is essentially the number of years the company could produce at 2014 levels based on year-end 2014 reserves. It is a measure of how long it would take the company to exhaust its proved drilling inventory at last year’s production pace, without considering potential future discoveries.

The other new metric is “Int/Rev.” This measure is of interest because it can tell us which firms are using up substantial portions of their revenue on debt servicing. (Bloomberg looked at this measure last week for some U.S. companies.) Two companies on the list — Encana and Paramount Resources — both paid out more than 30% of revenue as debt service in the most recent quarter.

Peyto is the 4th largest company on the list by EV. If we compare it to the group average, we see that it trades at one of the highest premiums in the group in terms of EV/EBITDA and EV/Reserves. However, if I were to look at long-term trends, Peyto would come out at or near the top in many categories. From 2010 through 2013 Peyto grew its gas production each year by an average of 36.5%.

It also ranks high for current financial performance. Two metrics I looked at but did not put in the table above were profit margin and cost of production. Peyto’s 27.9% profit margin was near the top of the list. The company’s production cost of $1.80/BOE ($0.29 per Mcfe – thousand cubic feet of gas equivalent) was only bested by one other Canadian company: Advantage Oil and Gas ($0.28/Mcfe), and two U.S. companies: Growth Portfolio recommendations Cabot Oil and Gas ($0.22/Mcfe) and EQT ($0.28/Mcfe).

Thus, Peyto’s higher multiple is at least partially justified by its high profitability and great long-term track record. Peyto did report a modest free cash flow (FCF) deficit last quarter (as did most of the other companies on the list) but it nearly stemmed the outflow during that reporting period.

The Canadian oil companies that made the cut are on average larger than the gas producers above, and they trade at an EV/Reserves premium because oil is generally more valuable per BOE than natural gas. (A barrel of oil contains as much energy as 6 Mcf of natural gas, so that on an energy-equivalent basis natural gas at $3/Mcf is like oil at $18/bbl.)

How do these metrics stack up against U.S. oil and gas companies? For comparative purposes, I will present the top 10 U.S. natural gas companies and top 10 U.S. oil companies — using the same definitions and metrics as I did for the Canadians. (Large integrated companies like ExxonMobil (NYSE: XOM) are excluded).

First, the gas companies:

Note that Cabot’s EBITDA and related metrics show the effect of a $771 million non-cash impairment charge taken in December to account for the diminished value of non-core oil fields in east Texas. Adding back that sum would yield metrics much more in line with the competition.

And now the oil companies:

On average the U.S. companies are larger than their Canadian counterparts, trade at a premium and have less debt. Among the gas companies, EQT and Cimarex both look to be in excellent shape, while almost all of the the oil companies shown in the table above are sound.

In the next issue, I am going to take a deeper dive into some of the U.S. gas companies, with a focus on the financials from their most recent quarter.

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