“Ingenious E&P Company Profits When Natural Gas Prices Rise … or Fall!”

What's Robert Rapier's pick, led by a Modern "Wild Bill" Mountain Man?

By Travis Johnson, Stock Gumshoe, September 29, 2015

This ad caught me eye as I was browsing a bunch of energy-related teaser picks recently — I’ve been starting to get tempted by the MLPs and the other energy infrastructure plays of late, and will probably be writing about some of the teaser picks for those sorts of companies in the near future… but this one’s a little bit different.

And it’s not an infrastructure company, not really — it is a natural gas producer, so there’s theoretically more commodity price risk than with a pipeline company (though, as a lot of the pipeline companies are finding, they get some commodity risk too — particularly when their contracted customers, the oil and gas producers, can’t afford to pay them for gathering systems or longer-distance transport), but Rapier’s teaser implies that this company will be profitable regardless of what natural gas prices do.

And we know that natural gas will get used, whether it’s to heat homes or generate electricity or, in a few years, get turned into Liquefied Natural Gas (LNG) and shipped off to an energy-deficient customer overseas (Japan, Korea, etc.), and prices can only drop so far before the market corrects itself and cuts into production… so is this one worth a look?

Well, we’ll at least find out the name of the stock for you.

Starting with the clues — Rapier has a nice storytelling bit to lead us in (though, frankly, he probably had nothing to do with actually writing the ad letter — his publisher has used almost exactly this same story to tease probably the same stock for Canadian Edge about five years ago — more on that in a bit), here’s a bit of the intro:

“Call this story ‘A Tale of Two Mountain Men’…

“Ebenezer William, or ‘Wild Bill,’ was a colorful 19th century adventurer, a living legend in his day, who trapped, prospected and guided pioneers across the rugged Canadian Rockies.

“Today, another mountain legend roams the same wild region. He’s the colorful ‘ramrod’ of what is likely the most efficient North American energy producer of them all.

“The company sells their natural gas for a ridiculous TRIPLE the production cost. They’ve maintained a staggering 34% average return on investment for the last 15 years. (By comparison, Exxon’s average ROI over the last 5 years is 13.2%.)

“Everyone from the chairman on down displays a fanatical devotion to their shareholders’ best interest. Get in now and stake your claim on a bonanza in capital gains… plus generous distribution checks arriving in your mailbox like clockwork.”

Now, it so happens that you could have pretty quickly come across the name of this stock yourself if Rapier had included Wild Bill’s last name in the tease… but that would be too easy, right?

Here’s a bit more, getting into teasing the actual company:

“Out in the wilds of Western Canada, there’s a brilliant E&P outfit defying one of the basic laws of economics—they profit when the price of natural gas rises… or falls.

“They’ve perfected a technique that allows a single wellhead to tap into multiple layers of gas simultaneously, boosting production dramatically and very cheaply.

“Stunningly low production costs have powered the company’s consistent profitability. A $1,000 grubstake invested in 1998 would be worth $461,530 today.”

Sounds impressive, right?

Well, that number is very close to what the company has posted in its presentations a few times over the years, and it’s not too far from what the reality would be for a longtime shareholder — had you bought shares in 2000, which is as far back as the data goes in my system for this one, you would be sitting on 13,000% gains.

Of course, a lot of that is due to the strong performance when the stock was very small and was generating 100%+ annual gains with some regularity — over the last ten years, the total return (distributions reinvested) is about 60% (or 50% if you’re a US$ investor, thanks to the exchange rate)… still pretty good if you consider that the broad energy index (as represented by the XLE ETF) is only up about 30% over that timeframe. But 50-60% total return in ten years doesn’t get anyone shivering with greed, which is why you see those numbers like “$1,000 turned into $461,000” … even though those kinds of returns are really only possible when you identify companies that are fairly small and destined for long-term greatness, and your chances of being wrong at that point, early in the growth of a business, are much greater than they are when the company’s management and strategy have been proven.

So what’s the secret “mountain man” company? It’s Peyto Exploration and Development (PEY.TO, PEYUF OTC in the US), which started life with that same name, then spent five or six years as an Energy Trust when those were the flavor of the week for investors in the late-2000s, and is now a regular corporation again.

Peyto is indeed one of the stalwart stocks of the Alberta Deep Basin gas production area — and they do produce natural gas very efficiently, and own much of their own infrastructure to help them manage costs. They are also, though no longer a royalty trust, very focused on shareholder returns, including cash returns in the form of dividends (the current yield is between 4.75-5%, depending on where the Canadian exchange rate hits).

They pay their dividends monthly, which some investors prefer — but it’s worth noting that dividend raises are not necessarily frequent, they’ve often gone well over a year without raising the payout and they have, at times, also cut it — though, to be fair, the only real dividend cuts came in the 2009 panic and when they converted from a trust back to a corporation, and pretty much every one of their peers probably made similar cuts.

And the name comes, of course, from Wild Bill Peyto, that mountain man of legend — who was so admired by co-founder Don Gray that he named the company after him in 1998 when he was just starting out with some retirement savings and a partnership with his neighbor Rick Braund, an oilfield “land man.” There’s a fascinating story about the early days of Peyto here from the Globe and Mail, though that article is more than 10 years old now and Gray has been out of the executive suite for eight years now (he’s still Chairman of the Board of Directors).

Peyto is now a $4 billion company, and they have indeed held up fairly well over the past year’s energy debacle, at least compared to some of the competition. Their earnings have dropped, but not all that dramatically — other than the last quarter, when they took an extra hit because of increased taxes in Alberta — and they have kept the dividend steady and been able to cover it with cash flow so far.

And Peyto is adored by some investors because of their strong cost controls and focus on “per share” metrics — you can get a taste of that from their last quarterly press release here and their most recent conference call transcript here.

I don’t know the company well, I don’t think I’ve looked at it in any detail since they converted from a Trust (around the time that Trusts lost their tax preference in 2010), but I do like the way the company explains, describes, and seems to manage the business — the focus on economic return for their capital investment, and on production and cash flow per share, is a lot more attractive than the “land grab” or acquisitive reserves building focus of many other energy companies. They have kept the share count under control, and their debt level seems quite manageable at about $1 billion and isn’t terribly expensive (they were able to raise $100 million at a 4.25% coupon just this Spring), so I’d be much less worried about their balance sheet than I am with many small or midsize energy companies now.

And while they don’t exactly profit from falling gas prices, they do hedge about 2/3 of their production at any given time to keep the balance sheet protected and plan their capital investments, so they’re more stable than some even if that means they won’t benefit quite so much if natural gas happens to spike to $5 because of a cold winter or something (though that seems not so likely, given the huge production capacity and the huge amount in storage).

So there you have it — a decent yield, a company that’s very focused on shareholder return and economically viable production from the Deep Basin in Alberta, and a favorite, we’re told, of Robert Rapier.

Just put your ideas of 13,000% or 50,000% gains off to the side, though. That’s almost certainly not happening again for Peyto, at least not within the next decade or two, and I assume even Robert Rapier would agree with me on that. Depending on when you bought Peyto, it’s possible that all of your gains over the past decade could have come from the dividend — with the dividends reinvested, Peyto is up 50% in US$ for the past ten years… if you took those dividends in cash and spent them, Peyto’s share price is actually down a little bit over that decade.

Interestingly, back when Roger Conrad was editing Canadian Edge for Investing Daily in 2010 (I think, it’s not dated), a very similar ad teasing Peyto was sent around by them — it’s still online in the backwaters of the internet here if you’re curious, you can compare it to Rapier’s current ad for The Energy Strategist here. So while I expect Rapier probably does like Peyto, we shouldn’t be under any illusion that he penned the words in the ad — it was a good story that worked to get investor attention five years ago, so they re-used it.

The last time I saw Rapier writing something about Peyto for any free sources was about a year and a half ago, when he said he liked it for aggressive investors but would prefer it to be cheaper — and it has fallen 30-40% since then (depending on which currency you’re talking about), so perhaps he really does think it’s well-timed now.

But it’s not his money we’re talking about, of course, it’s yours — so what do you think? Interested in “Wild Bill” Peyto’s namesake natural gas company in Alberta? Think the valuation and 5%ish yield are appealing? Scared away from all energy investments for the time being? Let us know with a comment below.


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11 Comments on "“Ingenious E&P Company Profits When Natural Gas Prices Rise … or Fall!”"

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livfr3
Irregular
1
livfr3

I believe Peyto is the lowest-cost nat gas producer in North America. Superb management. Despite trying conditions, its Canadian stock has held up relatively well, but US shares were hit by the strong USD/weak CAD. President/CEO Darren Gee writes a monthly report on its website, which is well worth reading. Peyto leverages its low-cost advantage by ramping up new production when prices are low and harvesting when prices are high.

barndoor
Irregular
13
barndoor

I bought this for $8.20 (USD at the time) in Nov 2008. So 150% paper gain and 6+ years of dividends. What’s not to like? And yes, It was Roger Conrad in early Canadian coverage.

I keep it now because:
1) it’s in a taxable account
2) what I read has always painted Peyto as a fierce Canadian competitor/leader, shareholder friendly business that is nonetheless beholdin’ to nat gas prices.
3) Travis’ comments don’t dissuade me–I view them as positive.

I have kept a few strategic energy stocks through the collapse of the last

rod
Guest
0

yes, I as well have been with Peyto since 2009 march/april bought at $8.00 pretty much could repeat the above comments , they hit a high of around $39.00 late last year and have been falling yes down around $26.00 cdn today sept-30-2015, I usually wait till end of Oct , then pick up more shares . IMHO they are a great buy now especially for US investors with a 30% more dollar value

Myron Martin
Guest
0

Have had this one under consideration for awhile and seems to have a good reputation.
A little above my pay grade, I prefer smaller companies with there growth potential still ahead of them, but as mature companies go Peyto seems a event pick.

smandell
Irregular
16
smandell

It seems to me that if we look at the relationship between $US and $CA, the $CA ought to be advancing, sooner or later. That said, does it matter if you buy in a $US account or on the Toronto exchange? Won’t the exchange rate be covered in the $US shares along with the price advance? Methinks so, but I’m interested in hearing comments.
Thanks, all.

Gordon Birkett
Guest
0
Gordon Birkett
Different subject >> ENERGY Stocks>>, What Co. is insider John Huff a part of and If you know what is your recomendation for that CO. Thanks GB
alberta doc
Member
0
I have owned PEY since the fall of 2015. Up 15% and will continue to build a larger position. Nat gas inventory should start to show a downward trend this winter as some estimates see a drop in current inventory by up to 25%. Why? Most of the high inventory numbers were caused by all the NG coming from the shale plays. Shale wells deplete much quicker than other NG wells. As an example, I live on a 80 acre parcel of land. Six years ago a NG well was drilled and completed on the back 50. Life of that… Read more »
utilitiesrock
Member
2
utilitiesrock

All these stks. seem vulnerable to the commodity price. To risky for old folks? Have been buying DM, a midstream nat.; gas play formed by D. Hefty payout increases forecast. Now 28.00 & change.

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