Since the production miss reported early in November, Eagle Energy Trust (OTC:ENYTF) has seen its share price drop from over $10 to a new record low of $6.77 per share. First it was the production miss, then tax loss selling kicked in followed up by unkind comments from TV pundits which only accelerated the route in the stock.
Does the 2013 outlook for Eagle Energy justify the selling frenzy or is there a buying opportunity? We'll let the numbers speak.
Eagle Energy Trust was the first of the so called "cross border trusts", a new breed of Canadian energy income trusts with assets exclusively in the US - in this case Texas. 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.
Eagle also reported a 65% DRIP (Dividend Reinvestment Plan) 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. First, let's confirm that our financial model reflects the company's guidance by loading the balance sheet for Eagle. Energy Trust. 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.
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 , 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. 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.
The screenshot above shows the old and new figures for DCF and EV/BOEPD. The DCF figure below 1.0x is excellent as it is one of the lowest when compared to peers.
At first glance, the investment case for EGL looks OK; the balance sheet is in a decent 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. What happens if the number of DRIP participants drop? The company breaks even at a DRIP participation rate of 47% and books a growing deficit as the rate drops lower.
While Eagle's bank line can absorb any resulting deficit (it currently stands at $48.5M), there's almost no wiggle room for commodity price volatility when you're counting on DRIP to generate positive cash flow. If the DRIP participation rate drops to 30%, this results in a loss of $5 million which would put the DCF ratio at 1.0x as debt balloons to $42 million.
Investing in junior/intermediate 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?
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 realizes a slight premium to WTI on its sales (pegged to Louisiana Light). Since the market is forward looking, it will likely ignore the company hedged 40% of is production in 2013 between $87 and $108.
Is Eagle Energy Trust a Buy/Hold/Sell? There's no clear cut answer as it depends on the level of risk you are willing to take on. As you can see, there's a very good reason behind the high yield. 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.
In my opinion, the stock has been oversold and should be trading above $8. On the other hand, I don't think we will be seeing $10 for some time. The company needs to put in a few quarters with no hiccups first. Finally, if the price of oil holds its ground above $85 WTI, there is almost no danger to the dividend in 2013 especially with the hedges in place. Remember that Eagle currently avoids the headache of price discounts producers in Canada have to deal with on a daily basis.