NEW YORK (TheStreet) -- When oil prices plummeted to their lowest levels in five years on Friday, Pengrowth Energy (PGH) took it on the chin. The small Canadian oil and gas producer, valued at $1.6 billion, saw its shares drop 17% during the week.
Investors may have overreacted, however. The Alberta-based company has attractive crude oil hedges, and its flagship project could start pumping oil as early as next month.
Pengrowth gets most of its output from the Canadian provinces of Alberta and Saskatchewan and pays attractive dividends to investors. (The current annualized yield is 13.8%.) Pengrowth has struggled with profits however, in part because of weakness in natural gas prices. It is now increasing its focus on crude oil and related liquids.
In this context, lower oil prices raise concerns about the company's future and its ability to continue paying dividends. Pengrowth is expected to report a net loss this year while its operating cash flows could sink by 11%, as forecast in an Oct. 31 report from AltaCorp Capital's analyst Nick Lupick.
The dividend fears are understandable because Pengrowth and peers such as Enerplus (ERF) reduced their distributions when oil and gas prices tanked two years ago. Last week, Seadrill (SDRL) , an offshore driller in the energy sector, suspended its dividends in part because of the weak crude price environment.
Waseem Khalil, a Pengrowth representative, did not respond to requests for comment from TheStreet.
Despite the concerns, Pengrowth is in a position to sustain lower crude prices in the coming years. The company has hedged 63% of its crude oil production for 2015 and 33% for 2016 at nearly $83 a barrel. This should protect the company's cash flows even if crude remains around $80 a barrel or lower, said Lupick. Credit Suisse analyst Jason Frew said in an Oct. 30 report that the company's hedging activity "should insulate the dividend" from the risks related to lower commodity prices.
More importantly, Pengrowth will start producing oil from the first phase of its flagship Lindbergh heavy oil project in January, the company said during the third quarter conference call. The project underpins the company's future production and cash flow growth. Lindbergh not only has higher quality of oil compared with similar projects, but also has significantly lower supply costs, making it attractive even if oil prices hover around $70 a barrel in 2015.
According to the company's November presentation, oil from Lindbergh would cost slightly more than $50 a barrel. On the other hand, the average cost of other oil sands and shale oil projects is more than $70 a barrel.
The first phase of Lindbergh project will add 12,500 barrels a day to Pengrowth's output, which is significant given the company's liquids production was 39,000 barrels a day in the previous quarter. With gradual ramp ups and contribution from Lindbergh's second phase, the company's total liquids output could increase to more than 51,000 barrels a day by the end of 2016, according to Credit Suisse estimates.
Eventually, by the end of 2018, Pengrowth estimates that Lindbergh alone would be producing 50,000 barrels of heavy oils a day, six times greater than the heavy oil production in the third quarter of this year.
Pengrowth Energy's shares have dropped by 50% this year and currently trade around $3.
At the time of publication, the author held no positions in any of the stocks mentioned.
TheStreet Ratings team rates PENGROWTH ENERGY CORP as a Sell with a ratings score of D+. TheStreet Ratings Team has this to say about their recommendation:
"We rate PENGROWTH ENERGY CORP (PGH) a SELL. This is driven by a number of negative factors, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. Among the areas we feel are negative, one of the most important has been a generally disappointing historical performance in the stock itself."
You can view the full analysis from the report here: PGH Ratings Report