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International Coverage Universe: Picks, Pans and Strategy for 2015

By Roger S. Conrad on Jan. 7, 2015

A dozen companies in our International Coverage Universe have slashed their dividends since oil prices started to plummet this fall. All these cutters hail from Canada and focus on oil and gas production.

(Click table to enlarge.)Cad Dvd Cutters Table

Almost all the companies listed in “The Damage Thus Far” are repeat offenders. In fact, with the exception of Baytex Energy Corp (TSX: BTE, NYSE: BTE) and former International Portfolio holding Bonavista Energy Corp (TSX: BNP, OTC: BNPUF), each company on our list is arguably in a long-term decline that, for some, stretches into the previous decade.

That’s the case for Penn West Petroleum (TSX: PWT, NYSE: PWE), which we’ve rated a Sell since we established Energy & Income Advisor’s International Coverage Universe.

The floundering exploration and production company announced plans to slash its quarterly dividend to CA$0.03 per share starting in April 2015—the firm’s second reduction in as many years.

By comparison, Penn West Petroleum disbursed a monthly dividend of CA$0.34 per share from 2006 to January 2009; the astounding 97 percent decline in its annualized dividend from that peak reflects consistently disappointing production and profits, as the firm has aggressively sold assets—often at suboptimal prices—to pay down debt reduce operating costs.

This latest reduction to the dividend and capital spending likely doesn’t mark the end of Penn West Petroleum’s pain. Management’s guidance assumes oil prices of $65 per barrel—about $25 per barrel more than the spot price of Edmonton Mixed Sweet and more than $30 per barrel higher than Western Canada Select.

If Penn West Petroleum’s price deck proves overly optimistic, the company could face a cash flow shortage that leaves it with two unpleasant choices: eliminate the dividend and slash capital spending even further or fund the difference by drawing on its CA$1.7 billion credit facility.

The firm will need to roll over these credit lines in 2016 and 2019 and must deal with CA$451 million in debt maturing at the end of 2016, an amount equal to about half its current market capitalization.

Can Penn West Petroleum survive to flounder another day? To a large extent, the answer rests on what happens with oil prices.

The direction of energy prices will also dictate the sustainability of all the cutters’ newly lowered dividends and, in some cases, whether they avoid bankruptcy.

Sell-rated Canadian Oil Sands (TSX: COS, OTC: COSWF), for example, reported third-quarter operating costs of almost US$45 per barrel of oil equivalent produced—the current sport price of Edmonton Syncrude Sweet.

And the company’s lower dividend and targeted capital expenditures assume that West Texas Intermediate (WTI) crude oil will average US$75 per barrel in 2015. Unplanned outages at its Syncrude facilities also raise questions about Canadian Oil Sands’ ability to meet its production target of 95,000 to 100,000 barrels per day.

Investors shouldn’t be surprised that the new generation of upstream income trusts has produced its fair share of dividend cuts.

But Argent Energy Trust (TSX: AET-U, OTC: ANGYF), Eagle Energy Trust (TSX: EGL-U, OTC: ENYTF), Parallel Energy Trust (TSX: PLT-U, OTC: PEYTF) and Twin Butte Energy (TSX: TBE, OTC: TBTEF) will only avoid further dividend cuts if oil prices rebound to US$65 to US$70 per barrel—the prices underpinning their revised guidance.

Zargon Oil & Gas (TSX: ZAR, OTC: ZARFF) has also based its capital spending, production targets and dividend policy on an average WTI price of US$70 per barrel. To worsen matters, the embattled oil and gas producer has CA$166 million in loans—about 137.5 percent of its market capitalization—that must be rolled over in June 2016.

Lightstream Resources’ (TSX: LTS, OTC: LSTMF) dividend and capital spending plans assume that WTI averages US$65 per barrel in 2015 and the 12-month strip for natural gas comes in at US$4 per million British thermal units—a bold assumption for the US Gulf Coast, let alone Canada’s disadvantaged AECO Hub.

Spyglass Resources Corp (TSX: SGL, OTC: SGLRF) and Trilogy Energy Corp (TSX: TET, OTC: TETZF) eliminated their dividends completely, so further cuts aren’t a risk with these names. Unfortunately, both companies find themselves in desperate circumstances. Spyglass Resources’ odds of survival look increasingly bleak, as the firm continues to sell assets to raise capital.

Endangered Dividends

As for names that could join the ranks of recent dividend cutters, Encana Corp (TSX: ECA, NYSE: ECA), which slashed its payout by 65 percent in December 2013, appears unlikely to deliver on its production target and capital spending plans for 2015.

The company’s guidance assumes that crude oil averages US$70 per barrel and the 12-months strip for natural gas comes in at US$4 per million British thermal units. Sell Encana Corp.

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