(Idea) Buy Veren, Avoid Baytex
Note to readers: Dollar values are in Canadian dollars unless otherwise specified.
Today’s fundamentals for WTI are consistent with a price in excess US $80 per barrel. However, prices remain stuck in the low US$70s. Bullish news flow and oil-price rallies have been met with indiscriminate selling of both oil futures and E&P stocks.
As always, indiscriminate selling creates opportunities. A prominent one in my mind is the opportunity for investors in Baytex Energy (BTE) stock to simultaneously reduce risk and retain upside by switching some or all of their position into Veren (VRN).
I’ve long been a fan of capitalizing on “baby thrown out with the bathwater” scenarios, and this is a textbook case. The “baby,” VRN, is getting sold along with the “bathwater” of BTE and others.
It’s clear as day to me that BTE would carry far more downside risk than VRN during a sustained bout of low oil prices. I don’t know what’s holding down oil prices. It could be anything from concerns about a looming U.S. recession, China’s economic weakness, loose 2025 supply/demand balances, or market manipulation. What I do know is that if any of these variables remain in effect, BTE investors will run a high risk of permanent capital loss. VRN, by contrast, will cruise through a downturn with relative ease. Its stock will then recover and, I believe, reach new multi-year highs.
Why is VRN Being Sold?
There are multiple reasons why VRN is being sold.
VRN is a new iteration of the old Crescent Point Energy. Crescent point had been one of the more poorly-managed Canadian E&Ps, with regard to both operations and capital allocation. The memory of the company’s breathtaking underperformance from 2014 to 2019 burned many investors, and no doubt the memory is still fresh among many. It’s not surprising that the current iteration is having a hard time shaking off the old reputation with longtime energy investors.
VRN doesn’t belong to the current outperforming E&P subsectors, U.S. shale and Canadian oil sands. Moreover, its heavy weighting in natural gas and higher debt load than peers provide reasons for investors to avoid it or switch to VRN’s better-performing peers.
At current oil prices, VRN’s free cash flow shrinks dramatically. I’ve modeled its cash flows and estimate its free cash flow breaks even at US$60.50 per barrel WTI, assuming $2.25 per mcf AECO.
At the moment, VRN is dedicated to reducing debt. The result of this capital allocation priority, coupled with shrinking free cash flow at lower oil prices, is that the company has not allocated significant free cash flow to share repurchases compared to its peers.
VRN is also one of the few large E&Ps that has not seen significant insider buying.
While these factors have driven VRN’s selloff, none of them should come as a surprise or be unexpected. They do nothing to change my view of the company’s intrinsic value and its attractive long-term prospects.