Parex Resource (TSX: PXT) is a Canada-based upstream company. Its operational interest lies in crude oil exploration, development, and production in Colombia. Through foreign subsidiaries, the Company holds interests in onshore exploration and production blocks totaling approximately 2.7 million gross acres.

Revenue Mix

Businesses                                                          Geography

Investment Rationale

• Debt-free balance sheet: The Company has zero debt in its balance sheet, which reflects strong cash flow generation ability of the group. Regardless of asset-heavy business model, the Company's prudent financial and operations management helps it to run without debt capital. The Company exited Q2 2020 debt-free with a cash position of US$ 334.4 million, working capital of US$ 339.3 million and an undrawn credit facility of US$ 200 million. Including the Company's working capital surplus, Parex has available liquidity exceeding US$ 500 million and expects to generate free funds flow over and above planned capital expenditures in 2020.

• Impressive portfolio of assets: The Company has an impressive portfolio of assets and is continuing to develop those assets while working on its netback. Despite an exceptionally challenging quarter, the Company generated an operating netback of US$ 9.95/boa, and funds flow provided by operations ("FFO") netback of US$ 9.96/boe from an average Brent price of US$ 33.39/bbl. This still comes out to US$ 41 million in CFFO in the worst quarter of the collapse, enough for the Company to cover its capital spending for the quarter.

Source: Company Presentation

• Higher free cash flow yield: The company is offering a lucrative free cash flow yield of 8.7%, which implies a solid financial health of the company. The company is well positioned to pass through this challenging time owing to its solid cash flow generating ability. Further, higher yield provides a higher margin of safety to the existing and potential shareholders.  

• Industry Leading Margin Profile: In the second quarter of 2020, the company reported gross margin of 68.8% whereas industry median stood at 45.8%, EBITDA margin came in 33.6% vs industry median of 21.9%. This reflects strong competitive advantage of the company against the industry.

Source: Kalkine Group, Refinitiv (Thomson Reuters) 

• Ample liquidity: The current ratio of Parex Resource at the end of Q2FY20, stood at 4.57x vs industry median of 1.12x, which is exceptionally higher within the industry and implies ample liquidity to meet its obligations despite a challenging time. Also, the quick ratio of the company stood at 4.55x vs industry median of 0.88x, which implies a higher contribution of liquid assets in the company's balance sheet, which is good.

• Risk Associated to Investment: The company is significantly exposed to the volatility in the oil prices, as the group witnessed a significant drop in the company's netback going from near US$ 30 / share in 2019 to US$ 10 / share for the most recent quarter. If the trend continues, the company's ability to generate the cash flow for shareholder rewards may drop significantly. 

2Q Financial Highlights

Source: Company Filing.

• During the second quarter of FY20, the average production was 40,858 boe/d (97% crude oil), a decrease of 18% on a per basic share basis over the prior year comparative period as a result of the Company voluntarily shutting in volumes in the low oil price environment in the second quarter.
• The Company’s benchmark Brent price decreased by US$ 35.13/bbl, while revenue decreased by US$ 40.67/boe in the second quarter of 2020 as compared to the second quarter of 2019. The decrease in revenue relative to the Brent crude benchmark is mainly a result of weaker Vasconia pricing and increased wellhead sales as compared to the comparative period.
• Royalties decreased by US$ 5.98/boe as a result of lower crude prices in the quarter.
• Production costs decreased by US$ 0.53/boe mainly as a result of the depreciation of the Colombian peso.
• Transportation costs decreased US$ 2.86/boe as a result of increased wellhead sales in the quarter.
• The company reported that Zero wells were drilled in Colombia compared to 11 gross (7.10 net) wells in the comparative period of 2019 in response to the significant decline in realized oil prices and the ongoing uncertainty in market conditions resulting from the COVID-19 pandemic.
• The Company exited Q2 2020 debt-free with a cash position of US$ 334.4 million.
• On June 24, 2020, the group announced its plans to increase production from Q2 levels and re-start capital expenditure programs due to the greater visibility to stronger netbacks.
• The company recognized net income of US$ 19.3 million compared to a net loss of US$ 3.8 million in the previous quarter ended March 31, 2020 and net income of US$ 101.5 million in the comparative quarter of 2019. The net income is primarily a result of a US$ 24.5 million recovery in deferred tax because of an 8% appreciation of the Colombian peso to US dollar exchange rate in Q2 2020.
• The group’s Capital expenditures were US$ 5.3 million compared to US$ 48.7 million in the comparative period of 2019. Capital expenditures were fully funded from FFO.
• In the third quarter of 2020, the company’s potential average production would be in between 42,000-44,000 boe/d and Q4 2020 range of 44,000-48,000 boe/d.

Top-10 Shareholders

Top-10 shareholders in the company held around 26.12% stake in the company. Fidelity Management & Research Company LLC, and Wellington Management Company, LLP are among the largest shareholder in the company and carrying an outstanding position of 7.07%, and 2.77% respectively. The institutional ownership in “PXT” stood at 52.56%, and ownership of the strategic entities stood at 2.59% respectively

Source: Refinitiv (Thomson Reuters)

Stock Performance

In a year over period PXT shares have tested a 52w High of CAD 25.11 on January 03, 2020 and a 52w Low of CAD 9.22 on March 18, 2020. At the last traded price of CAD 14.56, its shares traded approximately 42% below the 52w high and 57.92% above the 52w Low. This reflects a sharp recovery from the year’s bottom.

1-Year Price Chart (as on October 22, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA Based Valuation Metrics

*Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters) 

Stock Recommendation

The company has continued to maintain strong netback through 2Q 2020, the worst quarter of the pandemic, and has decreased its capital expenditures significantly. PXT has a long track record of shareholder rewards and generating strong cash flow. Further, the company has a debt-free balance sheet which implies negligible balance sheet risk for the company. More importantly, the group’s LTM Return on Capital Employed (ROCE) stood at 23.4% which is significantly higher, and the spread between ROCE and WACC  stood at 11.1%, which implies that the company is generating significantly higher free cash flow for its shareholder and ability to fund its growth through internal cash flow.

A debt-free balance sheet and a free cash flow yield of 8.7% and consistent track record of generating high margins and return to shareholders, shows that the company has built upon solid fundamentals. Prevailing tough times in the wake of turbulence in the oil prices and demand is offering a lucrative opportunity to enter this quality franchise available on the TSX and that too at a discounted valuation.

Therefore, based on the above rationale, we have given a “Buy” recommendation at the closing price of CAD 14.56 on October 22, 2020.

*Recommendation is valid at October 23, 2020 as well

Disclaimer

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.