Longview Oil (TSX-LNV) emerged on April 14, 2011 following the acquisition of almost all of the oil-weighted assets of Advantage Oil & Gas (TSX-AAV). The company has a low risk oil weighted portfolio in 3 core areas: West Central Alberta (60% Liquids), SE Saskatchewan (light oil) and Lloydminster (Heavy Oil). LNV’s business plan is based on a dividend growth model paying an annual distribution of $0.60 per share and 5 – 8% growth in production. While the company is targeting a 100% total payout ratio for capital expenditures + distributions, the dividend might have to be cut if the company intends to hit its sustainability ratio.
Last month Longview announced a $27 million reduction to its 2012 capital expenditure program bringing it down to $46 million down from $73M. Production guidance was reduced to 6,400 boepd (77% liquids) for annual average production and the exit rate, down from ~6,800 boepd. The company was simply reacting to lower oil prices and widening differentials. However, even with the cut, the total payout ratio is still above 100%.
While the stock price for Longview LNV.TO 6.95 [+0.05] has suffered like its peers, it currently sits below the Q3-2011 low. The market punished the company for reducing its spending (even if it was the right thing to do) and is signalling the dividend is still not sustainable. Let’s take a closer look at Longview’s numbers.
2012 scenario + price deck:
- Average production: 6,400 boepd (77% liquids)
- Edmonton Par oil price: $80 CAD
- AECO Natural gas: $2.10 /mcf
The realized price for oil is in line with company guidance which assumes $85-$90 WTI depending on differentials with Edmonton Par. Furthermore, our oil price is supported by hedges of 2,000 bopd in a $90 – $97 range which cover 45% of it’s oil production. It’s certainly not conservative given how quickly we saw the price of oil tumble a few weeks ago but realistic for 2012. The realized price of natural gas is insignificant in the overall picture as the bulk of cash flow is generated by liquids; YTD AECO has averaged $2.05 /mcf. Using 2012’s production guidance, the company needs to realize an average of $90 CAD per barrel in order to achieve a total payout ratio < 100%. In this environment, it’s always better to take the safer approach of using lower oil prices in predictions.
The total payout ratio comes out to ~117% meaning the company for 2012 is adding more than $10M to its debt. Even though total debt will end up about $105M drawn on a credit line of $200M, funding the dividend by borrowing money usually doesn’t last long. Longview would have to cut its dividend by 40% in order to run sustainable operations. Using a $0.36 annual distribution per share, the total payout ratio settles slightly below 100% as long as oil prices average around $80 CAD per barrel.
Since this is a new entity with little production history, the growth portion would have to wait for a few quarters. Having assembled an 89% oil weighted inventory of 244 net locations, growing production should not be a problem at all for LNV if we ignore Q2-12 figures due to spring breakup and third part facility outages impacting production levels. The company can easily repeat 2012’s capex program year after year for more than 10 years. The only variable that requires improvement here is really the dividend sustainability ratio.
Longview enjoys a large undeveloped land position in SE Saskatchewan (116 net sections) with multizone potential including Bakken and Midale light oil. Not to forget 123 net sections at Sunset prospective for Duvernay Shale in the oil generating window. LNV investors get the exploration upside as a bonus at this price which currently trades at a significant discount to NAV estimated at $15.12 per share by the company.
The one obvious risk to Longview resides in its exposure to the price of oil. Furthermore, I believe that maintaining its dividend through incremental debt is what’s currently undermining the stock even if the company can afford to do it this year and the next. If WTI oil holds around $90 and Canadian oil differentials remain subdued, there’s a good chance the debt that will be used to fund the dividend is cut in half. But with a net debt to cash flow ratio exceeding 1.7x for 2012 based on $80 CAD oil in an uncertain economic environment, I think it’s prudent to reduce the dividend in order to preserve balance sheet integrity and the loyalty of income investors. The dividend may be safe for the remainder of 2012, but I think there’s a chance a reduction is in the cards for 2013.
What do you think of Longview Energy?