Avenex surprised investors with a 20% dividend cut dropping its monthly distribution from $0.045 to $0.035 per share. The market retaliated swiftly by sending its shares 20% lower on that same day. The share price has since continued to drift lower signaling there might be more cuts to come. Is Avenex Energy?s dividend sustainable? According to my analysis, the answer is a conditional yes, lets find out why.
Avenex Energy AVF.TO 2.23 [+0.01] ?is not your typical E%P company as it is composed of 2 divisions: Oil and Gas and the Elbow River Marketing. Revenue is approximately split 70/30 between the 2 divisions with the Oil and Gas segment accounting for the lion?s share. Besides Raymond James, the company?doesnt?get any analyst coverage and that is probably because AVF has not issued new shares in years. The company is essentially an income play that mainly attracts retail investors chasing yield.
AVF?s production was initially targeted at an equal weighting between oil and natural gas but even though they ran a great hedging program on their natural gas in the past few years, it was the end of the road for them in 2012. Just like everyone else in the industry, they had not expected the magnitude of the collapse in natural gas prices. For 2012, in order to keep their POR at or below 60%, they had to cut the dividend as a reaction to losing 50% of their natural gas revenue which accounted for 33% of their cash flow. Furthermore, AVF has started shutting in unprofitable natural gas production which will take their 2012 average production down to 4,200 boe/d (55% liquids) versus more than 4,800 boe/d?(47% liquids)?in average production in 2011.
It?s time to look ahead into 2012 in order to find out how the dividend measures up to Cash flow. For this year, AVF will be paying $0.45/share in dividends which include Q1 monthly dividends of $0.045/share. The company will be averaging 4,200 boe/d 55% Oil + NGLs as a result of NG well shut-ins. Capital expenditures will be around $28M for the year. Elbow River Marketing will be generating $16M in free cash flow which is not really a conservative number but it is consistent with last year?s figures. Let?s run the scenario using the following price deck:
BTI Price Deck
- $85 Realized price per liquids barrel ($95 Edmonton Par)
- $2.00/mcf realized price for natural gas
The realized price per liquids barrel is really an estimate for what they will get paid for their light oil, medium oil and NGLs. In Q411, they realized $88.5/barrel of liquids so $85/barrel is an acceptable number for our budgeting purposes. Natural gas pricing is not conservative at all given that AECO spot price is currently below $1.60 but the roundup to $2.00 is consistent with the company?s estimate taking what hedges they had this year into account. It?s obvious that the 2,300 bpd of liquids (the 55% of production) will be doing the heavy lifting in terms of cash flow this year.
The basic payout ratio falls indeed between 55%-60% of cash flow just like the company is aiming for. However, the total payout ratio is a disaster at 125% of cash flow which means an extra ~$10M is needed from somewhere to bring the sustainability ratio down to 100%. Since the company is drawn more than 60% on its $80M line of credit, paying this amount through debt is not an option because their bank line will be reviewed in September later this year.? Obviously, don?t expect their bank line to be bumped up given they stand naked facing ever lower natural gas prices. ?Their salvation for 2012 will come through the sale of their Enervest Diversified Income Trust units and the balance of their real estate portfolio which will secure the $10M shortfall. Can you really blame management for cutting the dividend? Yes, that?s if you want to blame them for not cutting it a little bit more. In my opinion, they should have gone lower to a monthly $0.03/share which would have helped them shave off another $3M in distributions in 2013.
For 2013, using the same price deck, they only need to grow their production by 5% or an extra 200 barrels of liquids in order for the total payout ratio to go below the 100% mark. Of course, the risks are easy to spot in the form of even lower realized average prices for natural gas or liquids. On the other hand, the marketing division might achieve higher margins this year because of its expertise in rail transport. The division operates a fleet of approximately 1,100 rail cars which is a transportation method producers are increasingly seeking in order to avoid price differentials on Canadian crude.
The share price of Avenex had been stable for a while at a 9.5% yield prior to the dividend cut which implies that theoretically the share price should stabilize at around $4.40 at some point. Take note that going forward Natural Gas prices will pose less and less danger to the dividend because even if they average $1.00/mcf in 2013, they would simply push the total payout ratio up by ~7% to 107% and result in more production shut-ins. Had they cut their dividend to a monthly $0.03/share, the dividend would have been easily sustainable at $1/mcf with a 100% total payout ratio. ?Obviously, it is all conditional on strong liquids pricing and on averaging 2,500+ bopd in liquids. Having said that, I believe the chance for another cut is small even with downside risk to oil prices because the company hedged 42% of its liquids production for 2012. So the last risk we need to remember is the marketing division failing to achieve its annual average cash flow of $16M.
The current natural gas price environment could worsen in Q3 but it would really take a collapse a la 2008 in oil prices in order to panic about a dividend cut. We also need to remind ourselves that natural gas prices will not be staying at record lows forever. One thing is for sure with AVF is that it will be in the penalty box for a few quarters or at least until the outlook for NG prices improve triggering a recovery in AVF production volumes and cash flow.
What is your opinion on Avenex Energy?