Investors still struggling to digest Husky dividend conversion

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Husky Energy Inc. baffled its shareholders with an unusual, abrupt change to its dividend policy a week ago, and the market is still trying to decipher the move.

Last Friday, Husky introduced a series of defensive measures to brace itself against its own pessimistic outlook for the global oil market. A record quarterly loss and mass layoffs were necessary, the company said, in addition to the conversion of its dividend from cash to shares.

Canadian investors are, by this point in the energy correction, well acquainted with dividend reductions, suspensions and eliminations, but this was a different beast, said Rafi Tahmazian, a senior portfolio manager at Canoe Financial.

"They call it a dividend, but it's a monthly equity issue. It's an attempt to keep investors in," he said. "It sets a precedent. Not a good one."

The bygone days of prosperity in the oil patch saw the rise of dividend-paying energy companies, which maintained payouts even while aggressively investing in growth. This was possible with the price of West Texas intermediate at $90 (U.S.) per barrel. The crash of the oil market subsequently put many dividends in the energy space at risk.

Companies such as Crescent Point Energy Corp., Baytex Energy Corp., Penn West Petroleum Ltd. and many others cut or cancelled their dividends amid the 60-per-cent drop in crude benchmarks that started in the summer of 2014.

"We've seen many companies cut their dividends and be treated very well by the market, because everyone understands it's a prudent move," said Dennis da Silva, senior portfolio manager at Middlefield Group.

Few, however, saw Husky's dividend as imminently at risk, he said. The company had one of the better balance sheet positions of the Canadian integrated oil companies, it was considered one of the more stable, if less exciting, senior producers, and it happened to pay the most generous dividends of its peer group. Annualized dividends of $1.20 (Canadian) per year yielded around 5 per cent, based on the average share price over the last six months.

So investors were caught by surprise, said Ryan Bushell, portfolio manager at Leon Frazer & Associates. In announcing its third-quarter results, the company disclosed a reduction in its longer-term oil price forecast to $40 (U.S.) per barrel over the next two years. "It's good to be conservative, but they went pretty far down the road in terms of executing on that," Mr. Bushell said.

That bearish outlook resulted in impairments and writedowns causing a $4.1-billion (Canadian) quarterly loss. Husky CEO Asim Ghosh said in a conference call he wanted to make the balance sheet "bullet proof" to low and volatile energy prices. And to preserve cash, the dividend would be paid out in shares, a manoeuvre apparently without recent precedent.

The company framed the new arrangement as "a means to continue to issue the dividend." Analysts had a different take. "The move is, for all intents and purposes, a temporary cancellation of the dividend," said Raymond James analysts. CIBC World Markets said "a stock dividend has no tangible benefits for shareholders relative to no dividend at all." Shareholders would also see their investments diluted on a quarterly basis, analysts noted.

Investors reacted forcefully and unfavourably, pushing the stock down by as much as 17 per cent, lifting the dividend yield to more than 7 per cent – a level suggesting the stock was "broken," Mr. Tahmazian said. Even before the selloff, the stock was trading at a 10-year low, hardly a good time for what amounts to an equity issue, he said.

For dividend fund managers, the implications are unclear, Mr. da Silva said. Some funds may have mandates that don't allow for holdings paying share dividends. Other managers may have to sell their share dividends to finance distributions. "This puts you in a bit of a grey area," he said. "To create confusion in a weak market is very dangerous."

But the stock has rallied over the past few days, recovering almost three quarters of the value lost in the sell-off, perhaps an indication that investors have come around to the company's angle on the share dividend. "This is a call for this quarter. This is not a call in perpetuity," Mr. Ghosh said of the policy change.

While the company's motivations are not entirely clear, it's safe to assume the dividend change had the support of majority shareholder and Hong Kong billionaire Li Ka-Shing, Mr. da Silva said. And while a dividend cut may have been the safer and more sensible route, Husky likely wanted to preserve its standing among dividend investors, he said. "I think they just viewed it as important not to destroy the reputation as a safe dividend payer."