Shoreline Energy: Dividend Sustainability Analysis

Shoreline Energy is a dividend paying junior producer that IPOed in April of 2011. It has less than 6 million shares outstanding and currently produces around 2,000 boe/d (30% liquids).  The dividend ($0.80/year) was initially set when the price of natural gas was double what it is today but with NG prices sliding to record lows the company ended up with a yield exceeding 17% before it announced a cut earlier this month. Let’s take another look at the sustainability of its dividend.

Shoreline SEQ.TO 0.74 [+0.05] operates in north western Alberta providing investors pure exposure to the Peace River Arch area with 128,000 net acres in royalty and working interest. This region is extremely competitive with several larger players dominating the scene.  The area also enjoys an impressive geologic diversity providing companies with exposure to multi-stacked pay zones. This means that a well can be completed in multiple hydrocarbon bearing formations. This also means companies can re-complete existing wells in bypassed zones at a fraction of the cost of drilling a new well. In simpler terms, they can add a flowing boe/d at a lower cost range.

peace river arch statigraphy

multi-zone potential – click to enlarge

The dividend is great to have when it’s sustainable; it has been reduced to $0.12 on a quarterly basis for a 12% yield at $4.00. The dividend for 2012 is $0.56 assuming it is still $0.12 for Q3 and Q4. Let’s take a closer look at what to expect using the following scenario:

  • 2012 average production 1,950 boepd (30% liquids)
  • Realized oil price of $80 (Edmonton Par)
  • Realized natural gas price at $2.00 /mcf (YTD AECO Average @$2)

The result is not pretty, the operating netback is a measly $12 per barrel and their dividend is still not sustainable with a total payout ratio exceeding %450 based on a capex of $17.6 million. The price deck used is in my opinion realistic and not overly conservative. For oil prices, 40% of their production is hedged at ~$100 which should help them realize $80 per barrel and mitigate a sharp drop in oil prices. I wouldn’t be surprised if the company updates its dividend policy with a lower distribution for Q3 and Q4 if we see further deterioration in commodity prices.

Looking beyond the runaway sustainability ratio, the beauty of junior producers is that they can rebalance their production weightings in a short period of time. SEQ is planning to exit 2012 at 2,180 boe/d with 41% in liquids (a 400% increase from their 10% IPO level) and they can bring their liquids weighting upwards of 50% if they run a similar capex program focused on oil. The only thing I would change for 2013 is natural gas prices at $3.00 /mcf and an average production of 2,500 boe/d. Their total payout ratio immediately drops to ~100% which is the desired level where the company fully funds its dividend from cash flow. All they have to do is double their oil production which translates into adding less than 700 bopd. A realistic target in my opinion.

But all is not shiny with Shoreline, management runs the company as if it was a private entity, it is very hard to reach any of them in order to get detailed information. I never got a call back or an email reply from management. I was able to reach the CFO after numerous attempts. This is the biggest negative a public company can exhibit as it turns off the interest of potential retail investors. On the financial side, debt is growing fast this year with liabilities at $17 million at the end of Q1 putting the D/CF ratio easily above 3x. I’d rather see the dividend cut by another 50% down to $0.24 per year as this would easily lower their debt levels and ensure their dividend sustainability into the future.

The company’s acreage, area of operations and the low share count are a huge positive and keep SEQ on my radar. Not to forget a mild upside potential to natural gas prices (budgeting $3.00/mcf for 2013) which would have an impact on CF because the company enjoys very low operating costs due to owning infrastructure. However, an unsustainable dividend keeps many yield investors away especially with the current downward pressure in oil prices. One has to really look into 2013 in order to see value providing the company executes its capex successfully and providing realized oil prices average at or above $80 per barrel CDN. Lots of risks there even though 2013 is only 6 months away!

What do you think of Shoreline?