Since dramatically reducing their dividends a few months ago, and bottoming out with natural gas, high yield Canadian oil and gas companies Enerplus Corporation (ERF) and Pengrowth Energy Corporation (PGH) have both performed exceedingly well.
Below is a 2-month chart of the performance of these two equities (click to enlarge images):
Both Enerplus and Pengrowth are former Canadian Royalty Trusts, or CanRoys, which were similar to MLPs in the United States. Canroys were eliminated by the Canadian government and most subsequently converted into corporations. Several continued to pay out high monthly dividends, including these two, both of which pay out monthly dividends. Pengrowth ended 2011 with a 7.31% yield and Enerplus ended 2011 with a 7.82% yield.
Both companies also began to decline shortly after the start of 2012, following natural gas prices lower. ERF and PGH both have significant natural gas exposure, and natural gas was in a state of continuous decline from the summer of 2011 through the Spring of 2012. By the start of 2012 it had already become apparent that these companies would probably not be able to maintain their dividends due to the declining gas prices. Below is a chart of natural gas over the last year, bottoming out in late April.
On June 12, after five months of declining equity prices due to reduced reserve valuations and anticipated dividend cuts, Enerplus slashed its dividend in half, from 18 Canadian cents per share to 9 Canadian cents. Though ERF did continue to decline after this announcement, Pengrowth underperformed it as investors anticipated PGH would follow suit.
Investors had good reason to believe that PGH was likely to reduce its dividend in the wake of ERF's cut. The Canroy industry went through a series of cuts in late 2008 and into 2009, with ERF then also being one of the earliest cutters in response to falling oil and gas prices at that time. Enerplus reduced its dividend late in November of 2008. Pengrowth then reduced its payout in February of 2009.
As a result, many shareholders were not exceptionally shocked when Pengrowth announced that it would reduce its monthly dividend from 7 Canadian cents to 4 Canadian cents. As the two-month chart, above, showed, Pengrowth shares have largely appreciated since cutting their dividend by about 42.8 percent, indicating that the market had essentially priced in that significant cut.
Despite the strong recent performance by these two equities, with ERF appreciating by almost 37% over the last two months, and PGH appreciating by over 19%, both companies are still down roughly 33% since the start of 2012. This means that if these companies were to regain their valuations at the start of the year, they would both appreciate about 50% from their current levels.
About one month ago, on August 10, both companies reported Q2 2012 results in line with expectations. Both companies noted benefiting from the resurgence in oil and gas prices during May and June. Pengrowth completed its acquisition of NAL Energy and also achieved its first production from its Lindbergh assets.
Similarly, Enerplus reported increased production, largely founded on a seven percent increase in oil production. Then on August 20, Enerplus reported that it was selling its interest in Laricina Energy, a private Canadian oil sands development company, for net after tax proceeds of approximately $141 million. Enerplus plans to use the proceeds from the sale to repay outstanding bank loans. This is the first sale the company has announced since revealing plans to divest non-core assets to reduce debt and fund production growth. The company also noted that it intended to continue with its plans to increase production and shed non-core assets to both reduce debt and fund its production acceleration endeavors.
The strong summer performance by these two companies indicates a growing comfort with their businesses and the market valuations of them. During the last few months, strengthening oil and gas prices have allowed these companies to hedge some of their 2013 production at far better rates than were feared just a few months ago. Enerplus, for example, last reported that the company has 18,500 bbls/day of oil production hedged at US$96.17/bbl for the remainder of 2012, 14,500 bbls/day of oil production hedged at US$101.36/bbl for 2013, and that it began to hedge its 2013 natural gas supply in mid to late Q2.
Other factors may also benefit these high yield Canadian energy companies. For example, these companies also suffered when the U.S. federal government denied the Keystone Pipeline plan in its entirety. It is quite possible that the President might approve some additional part of the Keystone Pipeline in the next two months.
It also appears that any new European Union ECB bond buying program will be good for the Canadian dollar, relatively speaking. The program should help support European demand for oil, which should help support oil prices, as well as demand for the many other resources such as timber, aluminum, gold and other commodities that are abundant in Canada. Similarly, the anticipated continued U.S. easing/stimulus should be good for the Canadian dollar versus the U.S. dollar.
The Canadian dollar has been strengthening lately. At the end of August, the Canadian/US dollar exchange rate was 1.0138, which means that one Canadian dollar would get you $1.0138 in U.S. currency. One month earlier, at the end of July, the exchange rate was 0.9967, and at end of June the exchange rate was 0.9749. Such currency rates often ebb and flow, but it does appear that the recent and continuing trend, at least in the near term, is a strengthening Canadian dollar and a weakening U.S. dollar.
The exchange rate is currently 1.0289, so the Canadian dollar has only continued to increase in value compared to the U.S. dollar over the last two weeks, and is now 5.5% stronger than it was at the end of June. To a U.S. investor in these equities, that would mean that even though the payout from ERF and/or PGH has not changed, the change in relative currency valuations has increased the value of this month's payout by 5.5% versus the very same payout made just two months ago.
Given these many potential positive external forces that could benefit these Canadian oil and gas producers, it appears that their dividends are stable, that their assets should continue to appreciate along with energy commodity prices and that these two companies are likely to increase their production in the coming quarters. Moreover, the Canadian currency dividends that they pay may be an unappreciated characteristic to this high yield asset class that a growing number of investors could soon come to appreciate.
Further, many income investors might also welcome their monthly dividend payouts that now annualize a yield of around seven percent, or over half a percent per month. For these reasons, it appears that ERF and PGH are likely to continue to appreciate in the coming months, and especially if energy commodities are stable or increase, as a growing number of investors are likely to seek out investments with their characteristics.
Disclosure: I am long PGH.