Last quarter, Pengrowth Energy (NYSE: PGH) issued a stark warning to investors. Unless commodity prices dramatically improve, the company would not remain in compliance with certain of its financial covenants in the second half of 2017. Because of this situation, the company needed to find a solution to avoid a disaster. While Pengrowth had taken a series of small steps throughout the year, it recently announced a significant leap forward, which increases its optimism that it can seal a deal with lenders before time runs out.
Slicing into the core
Pengrowth Energy spent most of this past year cutting costs, which enabled it to generate excess cash flow and pay down debt. As a result, the company had reduced debt by 203 million Canadian dollars since the end of the year and had CA$139.5 million of cash on hand at the end of last quarter, which was enough money to repay a CA$127 million maturity early next year. In fact, because the company was on pace to end the year with more than CA$200 million in cash, it initially wanted to meet with the holders of that upcoming maturity to gain their approval to pay it off three months early. However, the company recently canceled that meeting and will pay it off at maturity in March.
Driving the decision to hold off on that transaction was a recent leap forward in progress to relieve its financial burdens. This advance came in mid-December when the company announced an agreement to sell a non-convertible gross overriding royalty interest in its Lindbergh thermal property for CA$250 million. Pengrowth agreed to pay a 4% royalty on existing output as well as from future development phases of these properties. Furthermore, the purchaser has the option to receive that royalty in cash or as production in kind.
That cash infusion seems to have eased lender fears surrounding the company's financial position, which appears to be why the company noted in a recent press release that it "remains optimistic that it will be able to reach an agreement with its noteholders that will provide it with the financial flexibility it needs to reinvest capital in its operations, develop the next phase of its Lindbergh property and to thrive as a thermally focused oil and gas producer."
The company also pointed out that note holders seem to be willing to not only amend certain covenants but to extend the terms of some series of notes. While the company did not state which notes it hopes to extend, it does have $400 million of debt maturing later next year as well as additional debt maturities in 2018. If Pengrowth can push back these maturities, the company could use its cash infusion plus cash on hand to reinvest in its business instead of paying back creditors.
Taking a page out of a successful playbook
Pengrowth's decision to seek a monetization transaction on its core Lindberg asset is somewhat of a strategy change for the company. Initially, the company had hoped to sell non-core assets to reduce debt. However, it lamented last quarter that "the asset sale market remains somewhat challenged given the current commodity price environment." Because of that, the company focused on monetizing risk management contracts to pull cash forward. While those sales helped, it still needed a needle-moving deal to ease its debt burden, which is what the Lindberg monetization provides.
That deal somewhat resembles what fellow Canadian producer Penn West Petroleum (NYSE: PWE) did earlier in the year when it sold two of its three core assets to bolster its balance sheet. While those transactions cut deeply into the company's asset base, Penn West Petroleum captured substantial value, enabling the company to repurchase a meaningful amount of debt, which virtually eliminated its financial problems. Those deals dramatically transformed Penn West Petroleum from a company in financial distress to one that's positioned to grow production by 10% annually. Pengrowth hopes that its decision to partially monetize one of its core assets will ultimately result in a similar transformation.
Pengrowth Energy knows that hope is not a viable strategy, which is why the company has had to act. While those actions have not gotten it back on solid ground just yet, it is heading in the right direction.