Stock Analysis: Eagle Energy Trust 2013 Outlook

The OGA Stock Analysis feature is a very powerful tool available to investors. At first sight, a stock’s balance sheet might overwhelm you with numbers. However, this case study will show you how you can use this feature to your advantage using a dividend paying energy company. Eagle Energy Trust (TSX-EGL.UN) was of the first of the so called “cross border trusts”, a new breed of energy income trusts with assets exclusively in the US.  Last week, Eagle released a 2013 capital budget of $US 24.0 million with the following guidance:

  • Average working interest production of 3,000 boe/d comprised of 88% oil, 8% NGLs and 4% gas.
  • Operating costs expected to average in the range of $12.00 to $14.00 per boe.
  • Funds flow from operations of approximately $41.0 million using the following assumptions:
    • pricing at $US 90.00 per barrel WTI oil, $US 2.90 per mcf NYMEX gas and $US 39.60 per barrel NGLs (NGLs price is calculated as 44% of the WTI price);
  • A basic payout ratio at 77% (distribution per share dividend by cash flow per share.)
  • A sustainability ratio at 136% (distribution + capital expenditures)/funds flow. This ratio is very important, it is a visual indicator of a company’s ability to fund its distributions from cash flow and develop its asset base at the same time.
  • A DCF debt to cash flow ratio of 0.8. The DCF is calculated by dividing a company’s total debt by its cash flow. The ratio indicates a company’s ability to satisfy its debts.

Finally, Eagle reported a 65% DRIP participation rate. This means that 65% of the cash it pays out to investors is recycled back into the company in exchange of new shares. Before we proceed, this case study requires you to have an account on this site. If you do not have one, please take a minute to sign up here : Now let’s open Eagle Energy Trust’s Stock Analysis sheet.  From the main stock list, click the Dividend Payers checkbox and select Junior from the Profile drop down list (please see image below)

selecting eagle energy trust from the list

As you can see from the screenshot above, Eagle Energy is the 4 th item in the list. Click on the Stock Analysis link and an overlay window will open. First, let’s confirm that our financial model reflects the company’s guidance. If you scroll down to the Basic Payout Ratio and Total Payout Ratio sections you will see the 77% and 136% figures right there. The funds flow of $40.9 million is right in line with company guidance of $41 million.

eagle energy trust 2013 payout ratios

The 77% basic payout ratio figure is shown in green because what the company is paying out per share is less than what it is bringing in. However, 77% is a bit high compared to the 50%-60% typically targeted by energy companies. The 77% percent does not account for the money the company has to spend in order to maintain/grow production. This is where the 136% figure comes in, the figure is in red because the company is losing $14.6 million in order to pay its dividend and maintain/grow production at the same time. (The 136% and the $14.6 million can be seen printed in red in the image above)

Since 65% percent of investors are recycling their dividend into shares (DRIP figure as per the company), out of the $31.5 million paid in dividends more than $20 million dollars are returned to the company. This means that in 2013, the company will theoretically be able to pay down its surplus of $5 million dollars on debt thanks to DRIP investors (DRIP Dividend Reinvestment Plan). This brings us to the amount of debt the company is carrying, $37 million as of 2012 exit according to company guidance. If we reduce this number to $32 million based on the surplus we see above, the debt to cash flow ratio drops to 0.8x which falls again in line with company guidance.

improving debt to cash flow ratio in 2013 - in theory at least

The figure above shows the old and new figures for DCF and EV/BOEPD.  The DCF figure is excellent compared to peers as it is below 1.0x cash flow. At first glance, the visual investment case for EGL looks good; the balance sheet is in good shape with no apparent danger of a dividend cut. However, since this is based on company guidance and DRIP, there's always a possibility a few things can go wrong. This is where you come in; your investment decision is based on your own commodity price outlook, comfort level with risk and your trust in EGL's guidance.

Obviously, there’s no free lunch when investing and the 13% yield you currently get reflects several risk factors (as well as institutional tax loss selling per the company's news release). Investing in dividend paying energy stocks requires you to keep an eye on commodity pricing as this is the biggest risk factor of all. Since production is 88% weighted to oil, if the realized price of oil drops to $80 would you still want to be holding this stock? Is the dividend still sustainable? It takes a few seconds to get the answer. Just enter 80 in the realized price of oil input box and click on recalculate to refresh the whole scenario for 2013.

Realizing $80 per barrel of oil hurts!

The first thing you will notice is that the operating profit per barrel drops by more than $6 which brings the annual funds flow down by $7 million. The sustainability ratio is a disaster at 164% and despite the DRIP money; the company is losing more than $1 million which means the debt is increasing because the company has to borrow to pay its dividend. Obviously, in this scenario, the dividend would not be sustainable and the market  prices in a cut taking the share price lower. Please take note that a realized price of oil at $80 means WTI oil is below $80 because the company realized a slight premium to WTI on its sales. (The market is forward looking, as such it might ignore the company hedged 40% of is production in 2013 between $87 and $108). Can we estimate the dividend cut? Of course we can. Assuming the company would want to keep similar payout ratios, enter $0.72 in the dividend per share box and recalculate.

hypothetical dividend cut

Reduced cash flow results in a reduced dividend with similar sustainability ratio. It is easy to run hypothetical scenarios on any dividend paying stock. This helps you identify what you are comfortable with in terms of payout ratios and dividend cut/increase expectations. What if 6 months into 2013, the company suddenly reports it is missing guidance this year as a result of modified drilling or completion practices? It takes you a few seconds to enter the lower production volume and recalculate. You will be in a position to take a buy/keep/sell decision in a matter of seconds based on the snapshot you generated. What is the impact of volatility in commodity prices for oil or gas? Set your projections and calculate. You will be able to identify a mental floor in commodity pricing as a stop loss for holding this energy stock. The stock analysis tool allows you to generate a forward looking snapshot of a company’s financial health upon which you choose to act buy/sell/short/keep .  Finally, this is the only tool that gives you the power to make an investment decision in a matter of seconds following a material news release.

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