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                                                         Geographic                                                                                                  

Investment Rationale

• Higher Positive Spread Between ROCE and WACC: Parex Resources has significantly higher positive spread between Return on Capital Employed (ROCE) and Weighted Average Cost of Capital (WACC). Spread between ROCE and WACC stood at 9%, which depicts management efficiencies in fund deployment. Also, the higher spread between ROCE and WACC shows that the company is generating higher free cash flow, which would bolster the group’s financial position and the company can fund its futures expansions through self-generated cash flows.

• Negligible Balance Sheet Risk: The company has virtually zero debt in its balance sheet, which reflects strong cash flow generation ability of the company. Despite an asset-heavy business model, the company’s prudent financial management and operations management ability helps it to run a business without debt capital. The company exited the third quarter with a working capital surplus of USD 370.7 million, excluding funds available under the credit facility, as compared to working capital surplus on December 31, 2019, of USD 344.0 million. The company has zero debt as of September 30, 2020. On September 30, 2020. Parex held USD 353.3 million of cash, compared to USD 396.8 million at December 31, 2019, and USD 350.2 million at September 30, 2019.

• Generating Significant Free Cash Flow: The company has consistently generated free cash flow and heading self-funded industry-leading production growth. Further, the company is offering a free cash flow yield of 7.6%, which is significantly higher and provide a greater margin of safety to the existing as well as potential shareholders. Further, in the third quarter of 2020, the company repurchased 2.3 million shares funded by free cash flow generated over the period.

• Stock is hovering in a Bullish Price Trend: At the last closing, shares of PXT traded well above the 5-day, 10-day, 20-day, 30-day, 50-day, 100-day and 200-day SMAs, which implies a strong bullish price trend in the stock. Further, a golden cross-price pattern is forming on the daily price chart with short-term 50-day SMA of CAD 15.04 is about to crossover its crucial long-term support level of 200-day SMA of CAD 15.61. A golden cross is rarely occurred price pattern and considered as a strong bullish technical indicator. Moreover, Price/200-day SMA ratio stood at 1.19x, which implies that the stock is hovering approximately 19% above the crucial long-term support level.

Technical Price Chart. Source Refinitiv (Thomson Reuters)

• 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.

Financial Highlights: Q3FY20

 Source: Company Filing

• In the third quarter under consideration, average production was 44,305 barrels of oil equivalent per day an 8% increase from the previous quarter production of about 44,850 barrels of oil equivalent per day.
• During the quarter under consideration the company recognized net income of USD 27.6 million (USD 0.20 per share basic) compared to net income of USD 19.3 million (USD 0.14 per share basic) in the previous quarter ended June 30, 2020 and net income of USD 57.3 million (USD 0.40 per share basic) in the comparative quarter of 2019;
• The group generated an operating netback of USD 23.10 per barrel of oil equivalent ("boe") and funds flow provided by operations ("FFO") of USD 19.53 per boe from an average Brent price of USD 43.34 per barrel ("bbl");
• The group’s FFO stood at USD 79.4 million (USD 0.57 per share basic) as compared to USD 142.7 million (USD 0.99 per share basic) for the prior year comparative period. FFO was reduced in the current quarter due to lower sales volumes and lower Brent prices.
• The company reported its capital expenditures at USD 17.8 million in the period.
• The company utilized a portion of free funds flow of USD 61.6 million to purchase 2,305,000 of the company's common shares for a total cost of USD 30.8 million (average price of CAD$16.45/share) pursuant to the Company's normal course issuer bid program.
• The company’s working capital was USD 370.7 million on September 30, 2020 compared to USD 339.3 million on June 30, 2020 and USD 279.9 million at September 30, 2019. The Company has an undrawn syndicated bank credit facility of USD 200.0 million; and
• The group participated in drilling 2 gross (1.55 net) wells in Colombia resulting in 2 oil wells, for a success rate of 100% compared to drilling 9 gross (5.30 net) wells in the comparative period of 2019.

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%.

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 18.52 (on December 03, 2020), its shares traded approximately 26% below the 52w high and more than 100% above the 52w Low. This reflects a sharp recovery from the year’s bottom.

1-Year Price Chart (as on December 03, 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)

Peer Comparison

 

 

Source: Refinitiv (Thomson Reuters)

 

Stock Recommendation

PXT has a long track record of rewarding shareholders and generating strong cash flow. Moreover, the company has debt free balance sheet, which implies negligible balance sheet risk. Further the group has maintained a positive spread between Return on Capital Employed and Weighted Average Cost of Capital, which implies that the company is generating gigantically higher free cash flow for its shareholder and ability to fund its growth through internal cash flow.

On the technical front, shares of PXT traded well above the 5-day, 10-day, 20-day, 30-day, 50-day, 100-day and 200-day SMAs, which implies a strong bullish price trend.

Therefore, based on the above rationale, we have given a “Buy” recommendation at the closing price of CAD 18.52 on December 03, 2020.

*Recommendation is valid at December 4, 2020 price as well.

Disclaimer

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