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2 Stocks to Avoid (and 1 to Buy)

By Matthew DiLallo – Feb 21, 2017 at 4:07PM

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These two Canadian oil and gas producers are falling behind while the third is ramping up.

There is a renewed sense of optimism in the oil and gas industry this year. Several companies are ramping up spending so they can get back to growing production. That said, not all producers are quite as optimistic, with some still stuck in a rut because of higher costs, which has them falling behind their recovering rivals.

Two companies that just can't seem to get going are Baytex Energy (BTEG.F) and Pengrowth Energy (NYSE: PGH). While both are working to address their issues, there are simply better options available to investors. One worth buying ahead of these two is Crescent Point Energy (CPG), which offers investors everything they'd want in an oil stock these days.

A Backlit Pump Jack in Alberta Canada.

Image source: Getty Images.

Getting back up on its feet

Baytex Energy significantly pulled back the reins on spending during the recent oil market downturn. In fact, the company completely stopped drilling in its home country of Canada last year because it simply didn't have the money. However, with costs coming down and oil prices improving, the company is getting back to work this year. It has already increased its budget from last year's 225 million Canadian dollar spending level up to a range of CA$300 million to CA$350 million in 2017, which is just enough capital to increase output by 3% to 4% compared to last year.

While that's a step in the right direction, Baytex Energy currently expects to produce an average of 66,000 to 70,000 barrels of oil equivalent production per day (BOE/D) this year, which is well below 2015's average rate of 84,648 BOE/D. The reason production has come down so sharply is that the company had spent significantly less than required to maintain its output for two straight years. Given the company's current cost structure, it could take it years to get back up to its previous peak because it just can't generate the cash flow needed at current oil prices to deliver a higher growth rate, partially because of its large debt load.

Still trying to shore things up

Meanwhile, Pengrowth Energy is even further behind. For 2017, the company only expects to spend CA$125 million, which is just enough capital to keep its output between 50,000 to 52,000 BOE/D. However, unlike Baytex, that's not even enough money to maintain production given that last year's average rate was around 57,000 BOE/D.

The reason Pengrowth still can't even maintain its current output level is that it has a significant amount of debt maturing in the near term. In fact, the company recently announced that it had taken steps to address that problem by using its CA$530 million cash position to retire all remaining 2017 debt maturities. That said, the company will still have about CA$1.1 billion of remaining debt, which will continue to hold it down until it finds a permanent solution. It's actively pursuing asset sales to pay down more debt, while also working with creditors to relax its financial covenants. However, until the company improves its financial situation, it will not be in the position to boost output.

a rural landscape of Alberta, Canada, featuring a pumpjack in a field.

Image source: Getty Images.

Starting to fly

Contrast these two companies with fellow Canadian producer Crescent Point Energy. For 2017, the company expects to spend CA$1.45 billion in capital, which is enough money to boost output to 183,000 BOE/D by the end of the year, up 10% from last year's exit rate. Further, the company can fully fund that spending plan and maintain its current monthly dividend rate, while living within cash flow at $52 oil.

That plan sets Crescent Point Energy apart from Baytex and Pengrowth in three ways. First, it's growing output by a much faster clip and off of a much higher base. Second, it's doing so while paying a dividend. That's something those rivals haven't been able to do since they suspended their payouts during the downturn, and neither appears likely to bring them back anytime soon. Finally, given where crude prices are right now, Crescent Point Energy should generate free cash flow this year, which it could use to accelerate production growth, increase the dividend, or make acquisitions.

One reason Crescent Point is so far ahead of these rivals is that it carries much less debt. For perspective, its debt as a percentage of enterprise value is currently 30%, while Baytex and Pengrowth are at 60% and 67%, respectively. That lower leverage means it's paying less in interest, which gives it more cash with which to drill additional wells.

Investor takeaway

Both Baytex Energy and Pengrowth Energy are still trying to get back on their feet after getting knocked down by the oil market downturn. Unfortunately, their large debt loads are still weighing them down. That's why investors should avoid those two stocks and consider buying Crescent Point instead, because it's not only ramping up production and still paying a dividend, it also has low-risk upside potential thanks to its ability to generate free cash flow at current oil prices.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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