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Investment Ideas Dividend cut fears grow as yields surge among Canadian oil producers

Canadian oil producers' ability to lure investors with generous dividends is being tested as cash flow is squeezed by crude trading near five-year lows.

Companies will have to choose between reducing capital spending or payments to shareholders, said Sprott Asset Management LP's Eric Nuttall.

"The true sustainability of the dividend model at current oil prices in Canada is highly challenged," said Nuttall, who oversees C$120-million ($106-million) at Sprott in Toronto. He predicted capital spending will fall 15 per cent next year and dividend reductions may follow if prices stay low. "The current oil price does not work for the industry."

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Canadian energy companies such as Baytex Energy Corp. with average dividend levels higher than their U.S. peers are grappling with tough choices after oil fell as much as 40 per cent from its high in June. The plunge accelerated last week after OPEC committed to maintaining its current output target amid a supply glut and a global battle for market share.

Canadian producers in the Standard & Poor's/TSX energy index have a dividend yield of 3.67 per cent, 35 per cent more than the average of the U.S. companies in the S&P 500 Energy Index today, according to data compiled by Bloomberg. The yield, which measures annual per-share dividends relative to a company's share price, is rising for many producers as their stocks fall.

'Strong Signal'

Dividend yields approaching 10 per cent are a "strong signal that the market fears their sustainability," said Robert Mark, director of research at MacDougall, MacDougall & MacTier Inc. in Toronto, which manages about C$6-billion.

At yesterday's close, Calgary-based Baytex was yielding 12.8 per cent, Canadian Oil Sands Ltd. was at 10.5 per cent, Penn West Petroleum Ltd. yielded 14.9 per cent and Crescent Point Energy Corp. was at 9.4 per cent.

Baytex plunged 54 per cent through yesterday's close from oil's June 20 high, compared with the 24 per cent decline in the S&P/TSX energy index. In that time, Penn West slumped 65 per cent, while Canadian Oil Sands fell 45 per cent and Crescent Point dropped 39 per cent.

The S&P 500 Energy Index fell 19 per cent over the same period.

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Nuttall said the pain should ease for producers if West Texas Intermediate, the U.S. benchmark, rises above $75 a barrel next year, as he expects.

Locked In

Some companies are also partially shielded from oil's slide after locking in future prices with hedging. Crescent Point had 37 per cent of its 2015 output secured at prices above C$93 a barrel as of Oct. 28, the company said in its third-quarter earnings statement.

"This is a great investment opportunity for people to collect a pretty high yield on a low-risk company," which has never lowered its dividend through six downturns in the price of oil, Crescent Point Chief Executive Officer Scott Saxberg said today in a phone interview. "Our hedging program keeps our cash flow strong and allows us to maintain our dividend, maintain our capital program and battle through this."

Penn West will maintain its dividend if it's pressured by persistent low oil prices by reducing its 2015 capital spending, Greg Moffatt, a spokesman, said in an e-mail.

"Depending on the extent and duration of commodity price weakness in 2015, we can adjust our capital plan as required in the second half of the year," Moffatt said.

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Siren Fisekci, a spokeswoman for Canadian Oil Sands, declined to comment, as did Andrea Beblow, a spokeswoman for Baytex.

'Later Stages'

"Cutting a dividend tends to be in the later stages of what you do," Craig Bethune, a fund manager at Manulife Asset Management Ltd. who focuses on energy and natural resources investments, said in an interview at Bloomberg's Toronto office today. "Some will continue to fund their dividends through the tough times, choosing to make asset dispositions, really anything but cut the dividend."

Reducing the dividend yield would free up extra cash for development at Baytex, Mark Friesen, an analyst at RBC Dominion Securities Inc. in Calgary, said yesterday in a note.

"We believe balance sheet preservation is paramount and that it will be important to see evidence of this in the company's 2015 capital guidance," Friesen said.

Canadian Oil Sands, the largest owner of the Syncrude Canada Ltd. mining project, is seeing its dividend challenged because it gets all its production from oil and doesn't use hedging, Michael Kay, an analyst at Bloomberg Intelligence, wrote in a Dec. 1 note. A $10 change in the price of oil results in a C$240-million change in cash flow, according to an Oct. 30 company document.

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The prospect of lowering dividends is particularly likely for some Canadian producers, Mark said.

"The risks of dividend cuts skew toward the juniors, the oil-heavy and the debt-laden," he said.

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