Over the past five years, investors in the oil and gas drilling and exploration industry have lost their shirts. On average, stocks in the industry have declined 17% per year. But not every company has fared so poorly. Peyto Exploration & Development (TSX:PEY), a natural gas producer in Canada's Deep Basin region, has produced 29% annual returns over the past five years.
Those excellent stock returns are the result of Peyto's unconventional strategy. The company is highly focused on returns on capital. It has deep knowledge of geology in the Deep Basin, and management acquires only acreage that's likely to be highly productive. The company invests most heavily when gas prices are low. Obviously, that's completely contrary to industry practice. But the cost of acquiring and drilling additional acreage is lowest when gas prices are low. It's unconventional, but based on the company's track record, it works. Over the past 13 years, the company's return on equity has average 38%.
Further, this strategy, along with geology of the Deep Basin, has kept the company's cost to harvest gas ultra-low. According to management, Peyto is the lowest-priced gas producer in Canada. Because of its low costs, Peyto is able to generate excellent profits on its production, even with today's low natural gas prices. In 2012, the company's cost per 1,000 cubic feet equivalent, or mcfe, of gas was $3.27 -- including finding, development, and acquisition and cash production costs. On average, the company sold gas at $4.21 per mcfe -- a 22% profit. Generating that level of profitability is pretty impressive, especially since lots of other gas producers are losing money these days. And management's goal for 2013 is to improve on those profits -- produce at $3 per mcfe, sell at $5 per mcfe, and generate a 40% margin.
Peyto was founded in 1998 by Don Gray and Buck Braund. Co-founder Gray is currently the chairman, and Darren Gee is the CEO. Gee, an engineer and energy industry veteran, joined Peyto in 2001, and he's been CEO since 2007. During Gee's tenure, production and proven and probable reserves have increased 38% and 77% respectively, on a per-share basis. During that same time, Peyto stock has appreciated by more than 80%, easily outpacing appreciation in the S&P 500. Considering the state of gas prices during this period, this is a truly impressive track record.
No doubt that Gee is a savvy operator. He's also proved to be quite transparent and forthright with shareholders. On a monthly basis, Gee publishes the "President's Report" on Peyto's website, which includes his thoughts on the industry, along with production and capital spending data. In January, Alberta Oil named Gee the CEO of the Year, and recently Morningstar named Gee as one of three nominees for is 2013 CEO of the Year Award.
Foolish bottom line
Of course, Peyto's success hasn't gone unnoticed. It's currently trading an unusually high multiple of earnings and cash flow. That doesn't mean the company is overvalued, but it's not a screaming buy, either, at least based on my current analysis. At today's prices, it's probably a good candidate for a small starter position, and at the least it should be added to your watch list of energy stocks.