Parex Resources Inc (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

Investment Rational

• High Margins: The company has consistently delivered very high margins and outperformed the industry peers at the same time. Over the past eight quarters to March 2020, the company has consistently delivered Gross margin above 80% and the EBIDTA margin above 65% over the past eight quarters and outlast its peers. However, in the June 20 quarter, given the turmoil in the oil market in the wake of demand slump and plunge in the oil prices led by COVID-19 pandemic hit company hard on the margin front. Despite an unprecedented challenging quarter, the company’s gross margin stood at 68.8%, and EBIDTA margin came in at 33.6%, which significantly outperformed the industry averages. This reflects the competitive cost advantage of the company against the peer’s average.

• Debt Free Balance Sheet: The company has zero debt in its balance sheet, which reflects strong cash flow generation ability of the company, as regardless of the asset-heavy business model of the company, its prudent financial management 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 of exceeding US$ 500 million, and the company expects to generate free funds flow over and above the planned capital expenditures in 2020.

• Solid operating netback: 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

• Strong Free Cash Flow Yield: The company is offering a lucrative free cash flow yield of 8%, which is an incredibly strong yield for investing at the current time.

• 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 $10/share for the most recent quarter. A glitch in oil demand would dampen the group's performance.

2QFY20 Financial Highlights

Source: Company Filing.

• For the three months ended to June 30, 2020, the Quarterly 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.
• Overall, 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 decrease is mainly a result of weaker Vasconia pricing and increased wellhead sales.
• Royalties decreased by US$ 5.98/boe as a result of lower crude oil prices. 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 no 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, 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.
• The group as on June 24, 2020, 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 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 for Q4 2020, the production would be in the range of 44,000-48,000 boe/d. 

Top-10 Shareholders

Top-10 shareholders in the company hold around 26.12% stake. Fidelity Management & Research Company LLC and The Vanguard Group Inc. are among the largest shareholder in the company and carrying an outstanding position of 7.06% and 2.87%, respectively. The institutional ownership in “PXT” stood at 55.04%, and ownership of the strategic entities stood at 2.51% 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 15.26, its shares traded approximately 40% below its 52w high and 66% above its 52w Low. This reflects a sharp recovery from the year’s bottom.

1-Year Price Chart (as on September 17, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV/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 generating strong cash flow. The company has continued to maintain strong netback through 2Q 2020, the worst quarter of the collapse, and has decreased its capital expenditures significantly. Further, the company's financial performance has been significantly improved over the last fiscal quarter, with Recognized net income of US$19.3 million (US$ 0.14 per share) compared to a net loss of US$ 3.8 million (US$ 0.03 per share) in the previous quarter. Moreover, together with improves performance in the second quarter of FY20, the company exited Q2 2020 debt-free with a cash position of US$334.4 million.

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%, implies that the company is generating gigantically higher free cash flow for its shareholder and ability to fund its growth through internal cash flow. This is the biggest competitive advantage PXT investors are enjoying.

Also, a debt-free balance sheet and a free cash flow yield of 8% 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 disturbance 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 15.26 (as on September 17, 2020), with lower double-digit upside potential, based on the NTM Peer's Average EV/EBITDA multiple of 6.2x, on the FY20E EBITDA.

 

*Recommendation is valid at September 18, 2020 price as well.

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