Looking for lost dividends in the oil sands
If companies slice their dividends, should you still own them? Yes, says this U.S. advisory, if they’re still growing — like this big Canadian firm.
If a company cuts its dividends, will you cut it?
In many cases, when dividends are reduced, investors will see a red flag and let go of the stock. But before you do, ask yourself this question.
Does the stock have growth potential?
Here’s how a leading U.S. advisory, The Complete Investor, puts it. “Income investors, naturally, pay a lot of attention to dividends, which provide income streams they rely on. But it’s also important to consider total returns — dividends plus price appreciation.”
Through the long months of the credit crisis and market slump, the advice du jour has been to buy dividend-paying stocks so you can receive income while you wait for capital gains to come out of their slumber.
So now you’re being advised to do the opposite. Hang on to those dividend-cutting stocks if you believe they can generate capital gains.
Having done so, of course, they would then build your dividends back up. That’s the theory, at any rate.
And one of the dividend-cutters this advisory thinks is still a keeper comes from Alberta’s oil sands.
Mammoth of the oil sands
In today’s rugged environment, says Ms. Genia Turanova, many companies have slashed their dividends, including some in this advisory’s Income Portfolio. Do they still belong there?
“To see if these companies remain good income vehicles, we need to evaluate their potential for price appreciation and future dividend increases.”
One vehicle that will keep on trucking is the mammoth of the oil sands, Canadian Oil Sands Trust (TSX-COS.UN; OTC-COSWF). Even though it now distributes just 15 cents after making several cuts from last year’s distribution, it stays in the Income Portfolio.
The cuts were a matter of prudence, not panic, Ms. Turanova explains. “The cuts were deemed necessary because of the company’s high leverage to the price of oil and to maintain an investment-grade credit rating.”
And a tidy little benefit turned up in the process.
Reinstating the DRIP
“In a further prudent move to deal with lower oil prices,” says the author, “Canadian Oil Sands has reinstated its distribution reinvestment plan (DRIP) to retain cash.”
That will keep the distribution stable. “For the foreseeable future, management plans to maintain the current distribution level, believing that annual production levels and cash preservation measures from the DRIP participation will let it fund both ample capital expenses and dividends.”
The price of oil matters to Canadian Oil Sands. Every $20 per barrel change in the price of West Texas Intermediate (WTI) crude pushes the cash from the company’s operating activities up or down by about $1.60 per unit.
If the price of crude settles at around $70 a barrel, cash from operating activities should rise to about $2.81 per unit. That’s a hefty increase from the $0.10 a unit reported in the first quarter.
But even if oil prices decline, this analyst reasons, Canadian Oil Sands’ strong balance sheet will mitigate the impact. In the wake of the Suncor bid for Petro-Canada, this giant remains the only pure oil sands producer, she adds. And it “remains one of the best operators, with rich resources that support substantial growth.”
Not making the cut
It doesn’t always work this way. Another commodity firm in the advisory’s Income Portfolio did not make the cut after cutting its dividend. Southern Copper (NYSE-PCU) reduced its payout when low copper prices led to weak first quarter results.
“This is the second dividend cut so far in 2009 and it pushed the yield down to a dismal level,” says Ms. Turanova. The shares, however, recovered from the deep slump induced by the drop in copper.
That offered a perfect opportunity to sell Southern Copper (and just in the nick of time — the shares have plunged again in the brief interval since the advisory sold them).
But that’s no reason to abandon copper and other base metals in the portfolio, says the analyst. To keep a lifeline to copper and increase the income in the portfolio, the advisory has purchased the shares of the world’s largest miner, Australia’s BHP Billiton (NYSE-BHP).
Trading at a lower valuation than Southern Copper and paying a higher dividend, BHP is simply a much better investment at the moment.
“And BHP’s strong balance sheet and diversified mix of businesses make it better positioned to hang in if the market takes a breather here,” concludes the analyst.
In short, look at the whole picture. A dividend cut may be a wise move rather than an alarm signal. One company may be in more trouble than it’s worth. But another may be gathering strength for the future.
You know the expression “Don’t throw the baby out with the bathwater” (a rather nasty one when you think about it).
So if the dividend level on an investment goes down, make sure you’re not throwing out some juicy capital gains along with that unfortunate infant.
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