Dividends are a wonderful thing, and stocks with high yields that can be sustained for a long time are a rare gem these days. In the oil and gas game today, though, there are several companies that have very tempting dividend yields, but the realities of the market suggest these fat payouts cannot last forever.
So we asked three of our contributors to chime in on stocks in the oil and gas space that look like they might not last and could be headed for a dividend cut soon. Here's what they had to say:
Dan Caplinger: Offshore drillers have been among the hardest-hit companies in the energy sector as a result of the plunge in crude oil prices, as offshore projects tend to be at the marginal-cost limit of financial viability and therefore are among the first to get mothballed when prices decline. Transocean (NYSE:RIG) has already slashed its dividend by 80% in response to the downturn in the offshore drilling industry, but the stock's share-price performance has pushed its yield back up toward the 4% level.
The long-term worry for Transocean is that it has a considerable amount of debt on its balance sheet. Earlier this year, bond rating service Moody's downgraded Transocean's debt to junk bond status, reflecting the uncertainty about whether a lasting recovery in oil prices will occur soon enough for Transocean's prospects to look better when it has to refinance its maturing debt. With a weaker bond rating, financing costs will rise, and that in turn could prompt further needs for liquidity. Right now, Transocean has about $2.7 billion in cash and another $3 billion or so in capacity on credit lines, and so a payout reduction likely won't happen in the near term. Nevertheless, Transocean remains at risk in the long run if energy prices don't recover in the way so many industry participants expect.
Bob Ciura: The last thing Linn Energy (NASDAQ: LINE) investors want to hear is that the company might cut its distribution again, since it already did so once this year. The price of crude oil fell from about $100 per barrel at its 2014 peak to roughly $45 per barrel at its 2015 low. This has caused Linn's cash flow to dry up, and as a result, its unit price is down 73% in the past year.
In response to the brutal collapse in oil and gas prices over the past year, Linn took the painful step of reducing its distribution by 57%, as part of a broader effort to reduce costs. In this same endeavor, Linn also cut capital spending by a whopping 65%. This has helped turn Linn into a leaner, more efficient company, and the good news is that management expects to fund its 2015 distributions and oil and gas capital spending entirely from internally generated cash flow.
Longer term, this is less certain, especially if commodity prices plunge back to the lows set earlier this year, or perhaps decline even further. Linn has some strong hedges in place that will help it in the near term. For example, Linn has hedged 80% of its 2015 oil production at an average price of $91 per barrel. Moreover, it is fully hedged on its natural gas production at an average price of $5.12 per MMBtu.
However, if oil prices keep falling and stay low for several years, the distribution may not be secure. Linn still has a lot of debt on the books. Linn's Berry credit facility has a borrowing base of $1.4 billion, but as of the end of last year, there was less than $1 million of available borrowing capacity. And Linn still has more than $10 billion in debt, as of the end of last quarter.
While Linn's 14% yield is attractive, the market is clearly not convinced the payout is secure.
Tyler Crowe: I'm very, very torn about the prospects of Denbury Resources (NYSE:DNR) right now. On one hand, the company looks incredibly cheap by so many metrics. On the other, though, its entire prospects could go up in smoke if there isn't any sort of price relief on oil.
Unlike other oil and gas producers that normally have a mix of the two, Denbury's production is almost all exclusively oil because of the unique process it uses to extract oil: injecting CO2 into older wells to repressurize it and remove remaining oil in the reservoir. There are some obvious benefits to this type of production, like close to zero exploration and finding costs, low decline rates at the wellhead, and very predictable production.
The one downside is that the process is a bit expensive, and Denbury has built a large profile of futures contracts to protect it from most of the price plunge thus far. However, as 2016/2017 starts to roll around, many of those futures contracts will have expired and Denbury could be exposed to current prices, which are not that economical for the company.
Denbury may not give out a whole lot of money in the form of dividends -- about $87 million annually -- and management seems to think that it can maintain its dividend for a while. If oil prices were to remain weak for longer, though, that $87 million might be needed for other more pressing needs, such as paying off interest.