Eagle Energy Trust recently released a dismal Q3 report triggering a drop in its stock price as investors question the sustainability of the dividend. While investors are correct in their reactions to a 200% basic payout ratio for Q3, I believe there’s a bigger picture to look at.
In my opinion, the important data from Q3 is that EGL assumed operatorship during this period, hired the necessary staff to ensure smooth operations and is almost done building the appropriate infrastructure in order to reduce operating costs. However, what I care about most as an investor is the sustainability of the distribution as I do not wish to repeat PMT’s mistake so this is going to take some number crunching in detail (I will spare you the excel sheets). Please note that I am no CFA and I do not have any funky abbreviations next to my name (except for the engineering title) but I did go to school when I was a kid and passed my math from elementary school all the way through engineering which should theoretically produce some decent results. (I encourage you to run your own numbers for comparison purposes)
In Q3, production came in below estimates at 995 barrels of oil per day due to 328 barrels temporarily shut in but for Q4 what I need to focus on is the fact that they are now producing 2,000 bopd and believe they will achieve the 2,400 bopd exit rate production. For Q4, with an average production of 2,000 bopd, I expect operating costs and administrative costs to fall on a boe basis. Current WTI oil prices are closing in on $100 again but for my assumptions I will use $90 to mirror their Q3 benchmark price.
Q4-2011 Scenario
Benchmark WTI $90 US
Average Production 2,000 bopd
Cash Distributions of $4.9M/$7.2M in FFO results in a payout ratio of ~68%.
For Q4, the basic payout ratio comes out below 70% which is a good start for a company that is targeting a 50% payout ratio. But this is not good enough for me as an investor as I need to get an idea on their 2012 payout ratio and their sustainability ratio (their ability to pay distributions and fund their capital expenditures from cash flow), for the 2012 scenario I will be using the following assumptions:
2012 Scenario
Benchmark WTI $90 US
Average Production 2,400 bopd
Capital Expenditures: $14M
Cash Distributions of $20M/$35M in FFO results in a payout ratio of ~57%.
For 2012 my numbers are somewhat conservative when it comes to production as I am assuming they will simply spend enough to maintain a production level of 2,400 bopd. The company usually would target an increase of 10% in production but I will use that 10% as a cushion for oil price volatility. The good news with this scenario is that the basic payout ratio comes down to about 57% while the very important sustainability ratio slips below 100 to settle around 96%. A substantial amount of cash supplied by DRIP investors is ignored in both scenarios; the amount is substantial because the participation level in percentage is in the high 60s.
At first sight, the 2012 scenario is positive and makes the current share price of Eagle Energy EGL-UN.TO 8.13 [+0.10] very attractive. However, focusing on the big picture is also focusing on the risk variables of which there are 2 that we need to account for when it comes to oil prices:
- There’s a powder keg known as the Middle East that could flare at any moment which would potentially push oil prices up to $200 triggering the collapse of the global economy. There’s a lot of talk about an Israeli strike on Iran before the end of the year.
- We have several European countries suffering from ADD who at any moment could trigger a financial meltdown bringing oil prices crashing. In any case, if for whatever reason WTI oil falls below $75 for an extended period of time, the distribution will be cut.
EGL.UN is a tax efficient “mutual fund trust” (not SIFT trust) that appeared in 2011 along with another energy income trust. It is currently yielding about 12% at current prices. I expect my 2012 thesis to be confirmed when the company releases its 2012 budget. I will also come back to this post once Q4 results come out in order to verify how close/far I have been.
What do you think of Eagle Energy Trust and of my numbers for 2012?
