After two challenging years, Baytex Energy (BTE -0.26%) was breathing a little easier as it entered 2017. That's evident by its initial capital budget, where the Canadian oil company increased its spending level from the 225 million Canadian dollars it spent last year up to a range of CA$300 million to CA$350 million this year. As a result, the company would be able to start growing its production once again.
That said, there's just one problem with Baytex Energy's 2017 budget: It needs crude to average around $55 a barrel to make it work. Otherwise, the company might have to borrow more money, which isn't something it can do given the impact its already massive debt load has on available cash flow. Because of this, investors need to recognize that the recent slump in oil could cause Baytex to make some changes.
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Breaking down the breakeven
At slightly less than $55 per barrel, Baytex Energy's cash flow breakeven level for its 2017 plan is on the high side versus its rivals. For example, the base level of fellow Canadian oil producer Crescent Point Energy's (CPG -0.51%) 2017 plan is $52 oil. That said, the number is even more impressive when we drill down and see what it covers. In Crescent Point Energy's case, it anticipates growing production 10% by the fourth quarter versus where it ended last year. That's a higher growth rate than Baytex Energy's 3% to 4% growth projection over that same time frame, and it's off a higher starting point of 167,000 barrels of oil equivalent per day (BOE/D), versus Baytex Energy's 65,136 BOE/D exit rate. Furthermore, Crescent Point Energy can achieve that growth and pay its quarterly dividend while living within cash flow at that $52 oil breakeven mark.
Crescent Point Energy isn't just an outlier. Penn West Petroleum (NYSE: PWE) is another company that can grow faster and at a lower breakeven point. In fact, the company anticipates that it can increase its production 15% by the fourth quarter of this year versus 2016's fourth-quarter exit rate. While that's from a much lower starting point of 28,655 BOE/D, it's still impressive considering that Penn West Petroleum can achieve that growth while only using 80% of expected funds flow from operations this year. Because of that breathing room, Penn West Petroleum anticipates self-funding the capex budget even if oil dropped all the way down to $40 per barrel.
Another company with plenty of breathing room in its 2017 budget is Canadian Natural Resources (CNQ -0.31%). While the Canadian oil giant based its budget on $55 oil, at that price point, it could generate enough cash flow to fully fund its CA$3.9 billion capex budget -- which would grow production 6% -- and pay $1.1 billion in dividends while generating $1.7 billion of free cash flow. Furthermore, Canadian Natural Resources built the flexibility into its budget so that it could roll back CA$900 million in spending if commodity prices weakened, while still delivering production growth.
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Drilling down into Baytex's primary problem
One of the main reasons why these companies have much lower breakeven levels for their 2017 budgets is that they have less debt on a proportional basis. In Baytex Energy's case, it ended last year with 6.4 times debt-to-funds flow. For comparison's sake, Crescent Point Energy's ratio was just 2.3 last year. Furthermore, the company expects that ratio to be just 2.0 by the end of this year. Because of its lower leverage, Crescent Point Energy is paying less in interest, giving it more cash flow for capex and dividends.
We see similarly stronger credit pictures at both Canadian Natural Resources and Penn West Petroleum. In Canadian Natural's case, its debt-to-EBITDA ratio will fall from 3.6 last year to 2.2 this year due to improving oil prices, a major project completion, and a recent acquisition. Penn West, likewise, has seen a dramatic improvement in its leverage ratio, which went from a dangerously high 4.6 last year to a projected less than 2.0 in 2017 due primarily to asset sales. Because of that, both companies are in a much better position to handle lower oil prices than Baytex Energy.
The company's hope was that oil prices would rise well above $55 per barrel this year, which would give it some excess cash flow to repay debt. However, with crude recently slumping below $50 per barrel, Baytex runs the risk of adding more debt to the pile. Because of that, the company might need to cut its capex budget to avoid outspending cash flow. Furthermore, the company seriously needs to consider selling assets or equity and get its leverage down to a more competitive level.
Investor takeaway
Baytex Energy's massive debt load puts it at a competitive disadvantage compared to other oil companies. That's because it is paying out a higher percentage of cash flow to creditors, which means it has less money to create value for shareholders. That should concern investors, because it increases the need for Baytex to take action and address the problem given crude's recent swoon and the impact that will have on cash flow.
