September 30, 2011 / 9:14 PM / 8 years ago

Analysis: Debt, dividend fears crush Canada's oil stocks

CALGARY, Alberta (Reuters) - A combination of falling oil prices and debt levels better suited to headier days is hammering Canadian oil and gas shares as investors fret that growth prospects are shriveling.

The steep drop in shares of PetroBakken Energy Ltd PBN.TO this week may be just the start of similar moves across the sector as the outlook for cash flows gets squeezed, putting dividends and capital spending at risk.

“The market is hypersensitive about any bit of bad news right now,” said Andrew Potter, an analyst at CIBC World Markets. “Any company with an operational upset is going to get hit disproportionately. Any company with a sniff of financial risk is being hit. The market is very sensitive about all these things right now.”

The Toronto Stock Exchange oil and gas group .SPTTEN has fallen 28 percent in the past four months, an even more pronounced drop than has hit oil prices. In the same period, U.S. benchmark crude is down 20 percent.

The nervousness was highlighted on Thursday by the panicked selloff of shares of PetroBakken, a Saskatchewan oil producer. The stock skidded on fears the company might have to suspend a rich dividend because of the weaker oil prices.

Many energy companies began the year predicting they would generate enough excess cash flow to make healthy regular payouts on top of money needed for exploration and development. Some had gone to the debt market to top up capital spending plans.

But oil prices have fallen as Europe’s debt crisis and a intractably weak U.S. economy have raised fears that a return to global recession would drive down demand. The higher debt levels on corporate balance sheets look more risky against expectations of reduced cash flow.

The gloomier outlook has already convinced some companies to trim spending before debt becomes a concern. Encana Corp (ECA.TO), weathering a prolonged slump in natural gas prices, has said it will not boost its debt next year, keeping its spending at or below its cash flow.

At $3.67 per million British thermal units, U.S. gas prices are 5 percent below where they were a year ago, a level that was even then considered depressed.


Dividends, treasured by yield-seeking investors, may also be at risk as companies look to conserve cash.

“We could see dividend cuts in the event we see energy prices remain low or go lower,” said Leslie Lundquist, a manager of Bissett Investment Management’s C$500 million ($481 million) Bissett Canadian High Dividend Fund. “But I doubt we would see cuts that are unexpected.”

Zargon Oil & Gas Ltd (ZAR.TO) cut its monthly payout by 29 percent three weeks ago to 10 Canadian cents a share, saying the move was necessary to allow it the financial wherewithal to keep its oil development plans in place.

Shares in the small producer have since fallen 15 percent.

Zargon was among the oil and gas trusts that retained high payouts when a change in tax rules forced them to convert to corporate status at the beginning of this year.

Many of these companies have been bruised. Daylight Energy Inc DAY.TO is down 47 percent since the end of May, while Pengrowth Energy Corp (PGF.TO) has shed 25 percent of its value over the period, and Penn West Petroleum Ltd PWT.TO is 38 percent lower.

“The majority of the former oil and gas trusts have been already crushed on this panic,” said Martin Pelletier, portfolio manager at TriVest Wealth Counsel Ltd. “I personally think there is an overreaction and those with a dividend are going to be more prudent with their capital programs next year because they have to, and can’t take the risk otherwise.”

Lundquist said she believes that the bulk of companies at risk of cutting dividends have already been singled out by the market, and now the overall weakness is presenting buying opportunities for companies with healthy balance sheets.

“You do see companies that have come off quite hard in some cases,” she said. “Where it gets a bit tricky is figuring who is going to maintain its dividend and should ... versus who probably will cut their dividend.”

Editing by Peter Galloway

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