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By Ishtiaq Ahmed

High dividend yield is one of the most important factors for Enerplus (NYSE:ERF) to be an attractive investment. Enerplus pays monthly cash dividend to its shareholders. Recently, the company cut its monthly dividends by 50% due to weak commodity prices. At the moment, the company pays monthly dividend of $0.09 Canadian dollars per share. As a part of our dividend stability articles, we went through Enerplus financials briefly. In this article, I will delve a little deeper and perform a free cash flows analysis, and look at the debt situation and expected earnings of the company.

Free Cash Flows:

Free Cash Flows

2011

2010

2009

Net Income

$109.00

$127.00

$89.00

Depreciation and other noncash charges

$440.40

$477.41

$619.66

Funds from Operations (FFO)

$549.40

$604.41

$708.66

change in noncash current assets

$22.00

$68.00

$42.00

change in noncash current liabilities

$52.00

$31.00

$26.00

Operating Cash flows

$623.40

$703.41

$776.66

Capital Expenditures

$1,132.00

$1,565.00

$578.00

Free Operating Cash Flow

-$508.60

-$861.59

$198.66

Long Term Debt

$844.85

$690.95

$496.40

Source: SEC filings

In the previous three years, net income of the company has demonstrated a mixed trend. At the end of 2009, net income stood at $89 million, which went up to $127 million in 2010. However, due to depressed commodity prices, net income for Enerplus came down to $109 million during 2011. Enerplus funds from operations declined during the past three years as depreciation, and other noncash charges came down. FFO for Enerplus came down to $549.40 million at the end of 2011 from $708.66 million at the end of 2009.

The cash flows from operations also demonstrated the same pattern as funds from operations. At the end of 2011, cash flows from operations stood at $623.4 million as compared to $776.66 million at the end of 2009. Enerplus has made significant capital expenditures in the previous three years. The company spent $3.275 billion in capital expenditures during the past three years. As a result, the company generated negative free cash flows in the past two years.

Essential Ratios:

Essential Ratios

2011

2010

2009

Funds from Operations(FFO)/Total Debt

0.65

0.87

1.43

FFO/Capital spending requirements

0.49

0.39

1.23

Interest Coverage

2.39

0.61

-0.07

Debt Service coverage

6.47

6.70

9.38

The first ratio shows that coverage provided to debt by FFO has deteriorated over the past three years. The ratio for Enerplus has declined substantially, and if the trend continues, the firm may face problems in the future. At the moment, the FFO is about 65% of the total long term debt. Recently, declining natural gas prices have hurt the FFO of the company. However, the FFO still remains adequate for Enerplus to cover its debt obligations. A sharp decline for Enerplus happened due to a decrease in FFO coupled with an increase in the total debt of the company. In the past three years, Enerplus debt almost doubled from $496.40 million to $844.85 million.

FFO to capital spending requirements ratio has also declined significantly, indicating the firm is not able to meet capital spending requirements internally. The firm borrowed funds to finance its capital spending requirements. On the other hand, borrowing does not seem to be a bad idea for Enerplus as the coverage ratios give encouraging signs. Interest coverage ratio was negative for Enerplus in 2009, which now stands above 2, a massive improvement. Further, debt service coverage have shown a decline, but still stands at above six, providing sufficient coverage to the company. Based on the coverage ratios, Enerplus should not have any trouble meeting its debt obligations. In fact, there is still room for Enerplus to borrow funds if need be.

Current Year Expectations and Impact on Metrics:

Enerplus reported net income of over $100 million at the end of the second quarter. The company also has plans to increase production levels as the commodity prices recover. Enerplus has a strong correlation with gas, and recovering gas prices will provide improved revenues for the company. In addition, the company aims to spend approximately C$800 million ($777 million) on drilling this year. A major chunk of this new investment will go to the Bakken shale-oil field, where the company plans to double the production. Improved operating results will impact these metrics positively, and the cash flow situation will improve at Enerplus.

Comparison with Peers:

Enerplus peers include Penn West Petroleum Ltd (NYSE:PWE), ARC Resources Ltd. (NYSE:ARX) and Pengrowth Energy Corp (NYSE:PGH).

ERF

PWE

ARX

PGH

Forward P/E

20.20

96.70

38.8

37.90

P/B

0.90

0.70

2.30

0.80

P/S

2.10

1.60

4.50

1.70

EPS Growth

-52.00%

-25.00%

-26.30%

-45.90%

Operating Margin

9.10%

13.30%

20.10%

5.30%

Net Margin

-8.30%

9.80%

9.80%

1.60%

ROE TTM

-3.50%

4.00%

4.80%

0.60%

Debt to Equity

0.30

0.40

0.30

0.40

Source: Morningstar.com

Based on the forward P/E, Enerplus is trading at a discount compared to its peers. The stock is also attractive based on P/B and P/S ratios. All the participants in the industry recorded negative EPS growth and faced declining margins due to depressed commodity prices.

Summary:

As a result of weak commodity prices and low expected cash flows, the company decreased its dividends. However, I believe the move was preemptive to safeguard the balance sheet of the company. I expect the company to report strong operating results during 2012 due to increased production levels and recovering commodity prices. There is potential in this stock for capital gains. Moreover, the juicy dividend yield is extremely attractive. Enerplus investors should have no fear of further dividend cuts, and enjoy its healthy cash distributions.

Disclaimer: EfsInvestment is a team of analysts. This article was written by Ishtiaq Ahmed, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Enerplus: Strong Dividends Set To Continue