Two dry holes, wasn’t that a punch line from the Golden Girls?: Parex Resources $PXT.TO

Probably Not a Value Trap

Welcome back to the “Probably Not a Value Trap” series where I discuss businesses with a 10%+ dividend yield which I believe probably won’t get cut and why, but don’t come after me on Twitter if they do.

This name could also be in the “FinTwit Favorites” category as it has been generating a lot of buzz on social media.  I know for some of you that is a sign of a stock to avoid, but to be fair, it was buzzing before the 30% drawdown.

I know that I have a US bias, and I am humbled that 60% of the subscribers of this newsletter are from outside of the US.  But sometimes I think investors are xenophiles trying to stick a pin in the map of every country by investing everywhere.  I don’t need every sector, and I don’t need every country, I just need returns. 

Parex Resources (PXT.TO), the Toronto listed, Columbia focused oil and gas explorer and producer broke a few hearts this past month when they announced that their drilling campaign on the Arauca field was suspended due to poor results. The stock price has subsequently dropped from $15 to $10, and the market capitalization similarly from $1.5 billion to $1 billion.  This stock price is very near the October 2020 low of $9.48, despite about 20% fewer shares due to buybacks, increased reserves per share, increased production per share, and an increased dividend per share.

First of all, the Arauca exploration campaign was only one out of three “Big E” exploration projects, as opposed to infill exploration spend.  Second, the rig and the crew at Arauca will be redeployed to block LLA-32 for infill exploration with a better probability of results for the second half of 2024.  Third, the poor exploration doesn’t impact Parex’s 54,000 barrel of oil equivalent per day production out of which they are returning 33% of funds from operation to shareholders, supporting an 11% dividend at this price, and reducing share count from 162 million in 2018 to 101 million today.

Regarding the opportunity in Columbia, the thesis of Parex’s management is that Columbia is relatively under developed and can have outsized results using technologies that have long since been deployed elsewhere, horizontal drilling, water injection, and polymer injection.  This is giving Parex a relatively low operating cost per barrel of oil recovered, although I don’t have information on all-in-sustaining costs.  The second major opportunity in Columbia comes from the fact that the country is in a natural gas shortage, and produced natural gas can be piped and sold domestically for attractive returns, probably for several years at least.  Parex just signed an agreement with Ecopetrol this April for a joint natural gas project which management refers to as transformational.

Management has committed to returning one third of funds from operations to shareholders.  This return of capital is currently split evenly between dividends and buybacks. Since 2019, Parex has returned $1.36 billion to shareholders, 2024 inclusive.  Not bad for a $1 billion market cap company.  Management is projecting about $600 million CAD funds from operation for 2024, with about $400 million CAD going to capex, and $200 million CAD going to shareholders.

So Arauca was a dud, there are still two out of three “Big E” exploration drilling programs underway.  Dry holes are something that happens in oil and gas.  Management is currently working on their 2025 budget and strategy, and they have a lot of options on how to deploy capital to try and maintain their 15% growth rate.  Taking a look at their production and portfolio as a whole, it seems likely that this price collapse was a large overreaction resulting in a buying opportunity.  

There are specific risks associated with Colombia.  I have an old friend who travels there regularly, and it seems as though every few years the story surrounding Colombia changes from optimistic to pessimistic and back again.  For Parex specific risks, there have been protests from local communities, and Parex deploys a social response team to try and get the local communities to buy into the project.  This involves hiring and training from the local communities as well as building an occasional home for the disadvantaged, or providing clean drinking water.  Just a cost of doing business.  Parex has been operating in Colombia for over 20 years, and they seem to have figured out the lay of the land, but every Latin American country seems to always be just one election away from socialism and expropriation.

Parex does have regular insider buying from the CEO and several directors, although their ownership stakes are small.  The former CEO is the current chairman of the board, who still owns over 1% of the company and sells occasionally.  I believe this is more about his lifestyle and less about confidence in the business.  Incentive alignment isn’t perfect, but it is better than most public companies.

I have been on the lookout for an oil and gas explorer and producer to eventually replace Vermillion Energy, but while I like Parex Resources, it isn’t a screaming buy unless you are an income investor.  The current prices are almost identical, with $1.6 billion for Vermillion’s 85k BOE/day vs $1.0 billion for Parex’s 54k BOE/day.  Parex has been returning capital to shareholders longer, but Vermillion was prioritizing debt paydown first.  Parex has Columbia jurisdiction risk, Vermillion has European jurisdiction risk.  Parex can sell natural gas at good prices in Columbia, Vermillion can sell natural gas at good prices in Europe. Both stock prices are depressed, and both are likely loaded springs to eventually enjoy some sort of rerating, but at an unknown time or catalyst.  

If I were an income investor relying on the dividend income, that would tip the scales in favor of Parex.  At my current stage in life, I would rather have the lottery tickets of Vermillion’s lawsuit against Ireland over the excess profits tax, as well as their projects coming online shortly in Germany and Croatia.  I’m less enthusiastic about the Montney project, it seems likely to be susceptible to a capex boom and bust from Canadian competition.  But overall, Parex is a solid pick that should enjoy a home in any income portfolio at this price.