Penn West's accounting woes raise red flag over valuations

Though the stock may rebound, there are better options in the exploration and production field.

Kirk Paulus 30 September, 2014 | 6:00PM
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Financial misstatements are fortunately rare in major financial markets and can range in severity from poor accounting judgments to illicit attempts to mislead. In the case of Penn West Petroleum Ltd. PWT, the company has delayed its filing due to material misstatements of expenses and asset values, to which the market reacted with a single-day price decline of more than 10% on July 30.

Uncertainty regarding the severity of these restatements has affected investor sentiment and the share price has trended even lower, currently languishing near $8. With a book value of $15.41, the stock appears to be a steal on value metrics, particularly for those investors seeking stocks trading at low price-to-book-value ratios.

Should Penn West be considered a value pick based on this depressed value? Realistically, we don't know, as the incomplete information creates huge uncertainty. For example, there may be huge asset write-downs or restatements, resulting in debt covenants being violated and $2.3 billion in debt called or restructured.

Analysts rely on the veracity of financial statements in order to make informed assessments of company value. Obviously, when the data is incorrect, and without knowing the extent of the irregularities, the usefulness of these data is greatly reduced.

In investing, we want to make informed choices that benefit our portfolios over the long term, not treat the market like a casino. Though it's possible that Penn West stock will rebound, there are better options in the exploration and production field. Parex Resources Inc. PXT, for example, is a far more attractive stock with a strong history of growth.

With a stellar history of production growth and a capable management team, Parex is positioned to keep growing its asset base of oil and natural-gas wells in South America. Parex rates strongly across momentum, growth and value metrics, and as such, should appeal to equity investors of all stripes.

The crux of the problem with Penn West is the opaque nature of the underlying data. With fundamental data that is unreliable, so too are many metrics based on earnings, cash flow or asset values.

The one metric that may still have some relevance is momentum, and in this Penn West also ranks poorly. Given its history, it is easy to see why, since Penn West was struggling even before revelations of accounting irregularities.

Many of these problems are rooted in the 2008 acquisition of Canetic Resources Trust for $3.6 billion. The valuation of this takeover was based on oil prices that were near their cyclical peak, shortly before the great recession. Penn West's timing was spectacularly unlucky.

Overpaying for Canetic, coupled with a poor integration effort, has already resulted in several large write-downs on Penn West assets. We don't know the details yet, but it is a fair guess that the restatements will reveal these asset values to be even lower than indicated by the numbers on the balance sheet.

The most obvious sign of trouble was Penn West's steadily declining production -- not something we want to see with exploration and production stocks. When the company slashed its dividend in the second half of 2013 as a result, even income-oriented investors had to abandon Penn West stock.

David Roberts has recently taken the helm as Penn West's CEO and is looking to sell off $2 billion in assets and turn around the company's poor production growth. Whether Penn West survives will hinge on how successful the company is in this turnaround and the extent of the misstatements.

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About Author

Kirk Paulus

Kirk Paulus  Kirk Paulus is an equity data analyst with the CPMS division of Morningstar. He holds a Bachelor of Business Administration degree from the Schulich School of Business at York University. He can be reached at but cannot provide individual advice.

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