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Message: Is Pengrowth Energy Corp.'s Survival Plan Working?

The struggling Canadian oil and gas company is making progress, but it has a tough road ahead of it.

Matthew DiLallo
Aug 18, 2016 at 4:30PM

Image source: Getty Images.

When a company's tag line for the oil market downturn is "survive to thrive," it is a pretty good indication that its survival is in question. For troubled Canadian producer Pengrowth Energy (NYSE:PGH), its survival is in doubt at the moment because it has more than $500 million in debt maturing next year, and it is close to breaching its financial covenants. While it has plans to tackle both issues, it still has work to do.

Drilling down into the problem

As of the end of the second quarter, Pengrowth Energy had $1.63 billion of debt outstanding. While that is a lot for a company of its size during the current environment, it is not the sheer size of its debt that's the concern. Instead, the greatest anxiety at the moment is the fact that Pengrowth has $400 million in debt maturing next year as well as $127 million of convertible debentures to address. Under normal market conditions, the company would likely just refinance this debt and roll it into the future. However, because of the market's current turmoil, that is not an option.

Instead, the company needs to figure out other ways to address these maturities. Since the start of the year, the company has begun to make headway, repaying about $225 million of debt. However, its primary focus was on paying down the outstanding borrowings under its covenant based $1 billion credit facility, which is now entirely undrawn after it paid its remaining $52 million balance last quarter. In addition to that, it has started building up its cash position and had $54.1 million of cash on its balance sheet as of the end of last quarter. Under its current assumptions, it projects to end the year with $150 million to $200 million of cash on its balance sheet. While that is a good start, it is not enough to wipe out its 2017 debt maturities.

An even bigger problem awaits

Pengrowth's hope is that it can use the availability under its revolving credit facility as a bridge to address the remaining balance on next year's debt maturities. However, while that $1 billion facility is completely untapped, it might not be available when the company needs it the most. That is because the facility is covenant-based, not reserve-based. As a result, its senior debt-to-EBITDA ratio must remain below 3.5 times for that money to be available. While that is not a problem at the moment given Pengrowth's current ratio of 3.1 times, it might be an issue next year.

The company noted the potential problem its second-quarter earnings release:

If commodity prices remain at or below July 1, 2016 GLJ forecast pricing for WTI crude oil and AECO natural gas and a U.S. $0.75 per Cdn $1 exchange rate, Pengrowth may not remain in compliance with certain financial covenants in its senior unsecured notes and credit facilities during the second half of 2017. If the Company is unable to obtain a waiver or relaxation of such covenants and is not able to remain in compliance with them, the senior unsecured notes and credit facilities may become due on demand.

In other words, while it has plenty of breathing room on the covenants right now, it needs oil and gas prices to rebound for it to remain in compliance next year under current projections.

One step the company is taking to address the problem is to seek a waiver from its lenders on the covenants to give it more breathing room. This request has been a common one in the sector during the downturn with rival Penn West Petroleum (NYSE:PWE), for example, successfully negotiating a covenant increase to 5.0 times senior debt-to-EBITDA in early 2015 to provide it some more breathing room. However, when Penn West Petroleum sought another covenant amendment earlier this year, its banks held firm. As a result, the company was forced to sell some of its prized assets to pay down debt and get back comfortably below its leverage limit. That might be the fate that awaits Pengrowth Energy. While it plans to sell up to $300 million of assets this to address next year's debt maturities, it might need to sell even more if it is in danger of breaching its covenants.

Investor takeaway

While Pengrowth is taking small steps toward addressing its 2017 debt maturities, an even larger issue looms. If commodity prices do not improve or its banks are not lenient, it might default on its financial covenants next year. That could force the company to take similar steps as Penn West and sell prized assets to stay afloat. In other words, it has not yet guaranteed its survival, which puts its ability to thrive in question.

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