Canada has been known as a resource based economy. We have a lot of the stuff that the world needs. From oil and gas, lumber, minerals, potash, precious metals and more. And then we can layer in fishing and agriculture.
But most of the attention (especially for investors) goes to the oil and gas sector. Canada has the world’s 3rd largest proven oil reserves. Surely we’re still sitting on an investment gold rush? Well, make that liquid gold of course.
And for this post will stick to the domain of traditional oil and gas investments – the producers. We’ll be back soon with a look at utilities and renewables that round out the energy space.
Oil and Gas Dividends Under Pressure.
During the first pandemic of modern times, no sector has taken a harder hit than energy. If we look at the TSX composite some 15 energy names were quick to cut or eliminate their dividends. The cutting crew includes popular names such as Vermillion Energy, Arc Resources, Crescent Point, Whitecap Resources, PrairieSky Royalty and Total Energy Services.
Never mind the cutting of dividends, many of these companies simply cannot turn a profit with lower oil prices. Of course, oil prices were crushed thanks to the reduced economic activity caused by the global recession; and then the market was flooded with oil thanks to Russia and Saudi Arabia.
It’s more than tough times for the industry. Global giant Shell cuts its dividend for the first time since World War 2. And Stock Prices Went Along for the Ride
Investors in the energy names have had to endure some crippling price hits. Here’s the year to date performance of the capped energy index from iShares, ticker XEG.
There have been no total returns for the index over a 10 year period. An investor would have been down a shocking 65%.
It is nothing more than survival mode for many of the Canadian oil and gas producers. They are cutting their capital expenditures and raising cash as fast as possible. They are playing it safe. And that could set up greater efficiencies and future profits and free cash flow.
Canadian oil was taken down even more than US Crude. Here’s a 1-year chart, courtesy of oilprice.com. And again what makes investing in oil and gas stocks ‘risky’ is that they are dependent upon that single input price for the oil and gas. And certainly every company is unique in its efficiencies and its break even point.
You might consider at what input price is a company profitable? How much debt are they carrying? How much cash and credit lines do they have available to get them through the tough times? What are the company’s proven reserves, and what are their exploration prospects? And of course, you’ll look to that payout ratio. That is always a good measure of dividend safety.
On a conference call on June 30th discussing Q2 earnings, Suncor CEO Mark Little offered that they need an oil price of $35 to ensure their financial health, cover dividends and allow for strong cash flows.
Bigger Can Be Better
Many would suggest that if you’re looking to ‘play it safe’ you might stick with the more integrated giants. That would be Suncor, Canadian Natural Resources and Imperial oil.
The big 3 energy dividends.
In Million Dollar Journey’s post on the top Canadian Dividend Growth Stocks you’ll find ‘The Big 3’. Given the recent challenges the dividends have held up reasonably well.
Canadian Natural Resources (CNQ) has maintained its dividend and offers a current yield of almost 6.3%.
Imperial Oil (IMO) has maintained its dividend. Offers a current yield of almost 3.8%.
After a dividend cut Suncor (SU) now offers a current yield of 3.7%.
Suncor cut its dividend by over 55%. When Suncor reported on July 22, revenues were down 57.9% and they swung to a loss of .40 cents per share (all in Canadian dollars). In the second quarter of 2019 Suncor had earned $1.74 per share.
Canadian Natural Resources experienced a loss of $1.35 per share in the second quarter. That compares to a profit of $3.17 in 2019. Revenue was down by 48.7% year over year. .
But on the good news front – The company achieved strong quarterly production volumes of 1,165,487 BOE/d, an increase of 14% from Q2/19 and comparable to Q1/20 levels.
Imperial Oil also experienced similar declines in profits and revenues. Even the big boys were hurt.
With economies now reopening and Canadian discount brokerage balances recovering, we would expect and hope that the worst quarter is in the rear view mirror. Economic activity and mobility is on the increase. They all had to accept lower prices for their oil production in the second quarter. And demand was suppressed thanks to the lock downs and the stay-at-home economy.
The Dividend Growth Story
On the income front the Canadian energy sector is still recovering from the energy recession of 2015. Here’s the annual distributions for XEG.
It has even been a bumpy ride on the dividend front. This is not the domain of sustainable and growing dividends.
That said it’s a different story on the Big 3 front. Here’s an equal-weight portfolio of Suncor, Imperial Oil and Canadian Natural Resources. The following chart represents income growth with dividend reinvestment, with a starting portfolio of $10,000, from 2003 through 2019.
It’s nothing short of impressive.
The chart is courtesy of portfoliovisualizer.com
Waiting For Economic Recovery
Like many businesses and sectors, oil and gas producers are waiting for an economic recovery that may depend on a miracle vaccine. We may have to wait a while on that, but who knows?
Most economists do not predict a quick V-shaped economic recovery.
Economic recovery is likely to be challenged. With high unemployment rates and the permanent loss of many jobs, it’s possible that the economic recovery will hit a ceiling. Think of it as the Nike swoosh shaped recovery. It stops short of where we were in 2019.
The challenges are many. There is a big hill to climb.
This remains a sector for the brave. There are incredible risks. That greater risk may not lead to incredible returns from these depressed prices. More dividend disruption may be in the cards.
But with greater economic activity in the US (and perhaps less reliance on shale oil) the Canadian oil producers might get on the path of increased revenues. We may see the continued increases in price for Western Canadian oil as well. We may have turned the corner.
Personally I don’t want to take on the risks of getting the oil and gas out of the ground and turning a profit and covering those dividends.
I like to remain a toll taker. I’ll stick to my pipelines.