At one time, Pengrowth Energy (NYSE: PGH) was one of the dividend darlings of the Canadian oil sector. However, due to tax law changes and persistently weak oil and gas prices, the company's dividend-paying days are over, at least until it gets back on its feet again. In order to do that, it must address its biggest problem: its balance sheet. Not only is Pengrowth dangerously close to breaching its debt covenants, but it has looming debt maturities that need to be addressed.
Close to hitting the limit
Pengrowth Energy has taken its balance sheet woes very seriously. It has significantly reduced capex spending in order to generate some excess cash flow to pay down debt. Last year, for example, it slashed spending to a mere $184 million, which is down substantially from the $904 million it spent in 2014, and when combined with a significant reduction in its dividend, enabled the company to use $280 million in cash flow for debt repayment. Furthermore, the company has completed a number of asset sales, including $211 million last year, which were also applied to debt repayment.
This year, it made another round of deep cuts, including reducing capex spending to just $60 million to $70 million, while also suspending the dividend to free up even more cash flow. At current commodity prices, the company anticipates being able to apply $280 million of that freed-up cash flow to debt reduction. Despite all that progress, it is still getting dangerously close to hitting the covenant limits on its debt, which is shown on the slide below:
Image source: Pengrowth Energy Corporation investor presentation.
The good news is that the company isn't expected to go over its limits, and that's based on oil staying much weaker than it is at the moment. That being said, it is looking to make sure it avoids breaching these limits by planning to sell another $300 million in assets this year in order to further reduce its debt.
Despite the concern, it's in much better shape than rival Penn West Petroleum (NYSE: PWE), which is projected to breach its debt covenant as early as the end of the second quarter. In fact, Penn West Petroleum's senior debt-to-EBITDA ratio is already a hefty 4.6 times, which is a lot higher than Pengrowth's and dangerously close to the company's 5.0 times covenant. It's a limit that it has already had amended in the past and one it's seeking to have amended again so it doesn't default. Seeking an amendment is a path that Pengrowth could pursue if it needed some extra breathing room on its financial covenants.
The looming maturity
As things stand right now, Pengrowth Energy won't default on its debt covenants this year and likely won't need to amend them in order to avoid a default. However, it still has another balance sheet concern on the horizon -- its 2017 note and convertible debenture maturities, which are shown on the following slide:
Image source: Pengrowth Energy Corporation investor presentation.
As noted on that slide, the company has $537 million in borrowings to address over the next year. It hopes to generate $355 million in cash flow that can be used to address the bulk of this maturity, especially if it's able to make early offers to retire some of this debt at a discount. Otherwise, it will need to succeed on asset sales in order to extinguish this debt when it comes due. Asset sales seem to be the chosen path for debt reduction in the sector, with Penn West Petroleum also hoping to sell additional non-core assets this year in order to address its own balance sheet woes.
Investor takeaway
Pengrowth Energy has a debt problem, which it's hoping to address in 2016. In order to do so, it has significantly cut back spending while also suspending its dividend in order to generate excess cash flow. On top of that, it is hoping to sell assets in order to push its debt reduction plans over the top so that it can survive the downturn without having to restructure through bankruptcy. Successful asset sales are the key to overcoming this problem because it would enable the company to address its looming debt maturity, while also pushing it back from the brink of breaching its debt convents.
