If there is one thing the recent downturn in energy prices taught investors it's that virtually no dividend is safe, especially among energy stocks with higher yields. This is after many oil and gas producers cut or eliminated their payouts as a result of weaker than expected oil and gas prices. Many more could still cut their payouts if prices don't improve. Three natural gas stocks that top the list of high dividends that are at risk of being cut are Chesapeake Energy (CHKA.Q), Vanguard Natural Resources LLC (NASDAQ: VNR), and Atlas Resources Partners L.P. (NYSE: ARP).
Why Chesapeake Energy's dividend is risky
While Chesapeake Energy's dividend has barely grown over the past five years, its yield has actually skyrocketed as we see on the following chart.
The main reason the stock is now yielding almost 3.5% is due to the fact that the stock price is down almost 50%. It's that inverse relationship between stock price and dividend yield that now puts Chesapeake Energy into the high dividend yield class for the first time in years.
That said, the reason why the stock price has been cut so deeply is because the company's cash flow continues to weaken along with lower commodity prices. Given current commodity price and spending projections, Chesapeake Energy is on pace to have a free cash flow shortfall of $2.1 billion this year and $2.7 billion next year according to analysts. One way the company can reduce its shortfall is to eliminate the $230 million in dividends it pays to investors each year. It's a scenario that's growing more likely the longer commodity prices stay weak.
Why Vanguard Natural Resources distribution is risky
Another investor payout at risk of being cut is the nearly 10% yield currently being paid by Vanguard Natural Resources. It's a distribution that has already been cut once this year by 44% and is at risk of being cut again if conditions don't improve. One of the chief concerns is the fact that Vanguard's natural gas hedges begin to roll off next year, which leaves it much more exposed to weaker oil and gas prices. We can see this in the following slide.
Source: Vanguard Natural Resources LLC Investor Presentation
As that slide notes, Vanguard's natural gas production is 84% hedged this year, but pro forma for its two pending acquisitions will only be 69% hedged in 2016 and 40% hedged in 2017. That leaves the company wide open to the downside of natural gas as its price is already down about 10% so far this year, which will impact the cash flow that currently underpins Vanguard's 10% yield. Suffice it to say, if natural gas prices don't meaningfully improve heading into 2016, Vanguard Natural Resources' distribution could be cut again.
Why Atlas Resource Partners' distribution is risky
Atlas Resources Partners has the highest yield of the group as it's yielding an unbelievable 24.3% at the moment. This is despite the fact that like Vanguard its payout has already been cut once this year. However, given how high the yield is at the moment, investors are betting the payout will be cut again.
The reason investors expect the payout to be cut is because nearly a quarter of the company's production margin is currently unhedged, which leaves it wide open to commodity prices volatility. In addition to that, investors are nervous about the company's debt and liquidity as it has taken on a lot of debt to acquire oil and gas properties over the past few years. The biggest concern is the company's credit facility as the company has borrowed $544 million of its $750 million borrowing base. That borrowing base could be reduced by its banks if commodity prices don't improve, which could force the company to cut the payout and use that cash to pay down some of its outstanding borrowings.
Investor takeaway
After what has happened to oil and gas dividends over the past year, it seems as though no energy-related dividend is safe anymore. Three that appear to have the highest risk of being cut among natural gas stocks are the payouts of Chesapeake Energy, Vanguard Natural Resources, and Atlas Resource Partners. All three are facing a cash flow crunch from weak commodity prices, which could lead to their high current yields being reduced over the next year.
