Husky Energy: The Dividend May Never Return

Summary

• Husky Energy announced a massive 90% reduction to their dividend when releasing their first quarter results for 2020, which was not surprising given their poor historical dividend coverage.
• Their leverage will continue increasing throughout 2020 and based upon my calculations it will likely take them at least five years to deleverage once conditions recover before increasing dividends.
• Unless there is a large and sustained spike in oil and gas prices, they appear to only be able to sustain approximately one-third of their previous dividend even after deleveraging.
• Whilst they can handle their debt maturities during 2020, the picture is less clear around 2022 and 2024 and thus shareholders should continue monitoring this situation.
• Since the world is moving away from fossil fuels, their dividend may never return to any material extent and thus I believe that maintaining my neutral rating is appropriate.

Introduction

When Husky Energy (OTCPK:HUSKF) released their results for the first quarter of 2020 they also announced that their dividend will be reduced by a massive 90%, which as I explained in one of my previous articles, should have come as little surprise. Whilst they still technically pay a dividend, considering their dividend yield is now sitting only slightly above 1%, it certainly has little to offer income investors. Unfortunately for their shareholders there are few reasons to believe that they will ever become a high yielding investment once again in the future.

Dividend Coverage

When assessing dividend coverage, I prefer to forgo using earnings per share and use free cash flow instead, since dividends are paid from cash and not from "earnings". The graph included below summarizes their cash flows from the last quarter and previous four years.

Image Source: Author.

It was analyzed and discussed in my aforementioned previous article how their inability to cover their dividend payments during 2018-2019 set a poor scene heading into this downturn and thus made them risky even if the coronavirus had not ravished the world. Based on their average free cash flow during 2017-2019 of C$190m, it indicates that once conditions normalize they could afford a dividend that is about one-third of their previous level that costs C$503m annually. Although their ability to provide any future dividend increases will depend on their requirement to deleverage and thus in turn, their cash flows going forward since it determines the extent that their leverage increases.

Upon analyzing the first quarter of 2020 their operating cash flow decreased by 32.41% year on year from C$469m to C$317m, after including the items listed beneath the graph that outrank dividend payments. Even though this is already less than ideal, the situation actually worsens after removing the impact from their working capital build of C$414m and draw of C$330m for the first quarters of 2019 and 2020 respectively. This means their operating cash flow excluding working capital movements was completely wiped out and decreased 101.47% from C$883m to negative C$13m.

Given this performance and the fact that operating conditions have worsened since the end of the first quarter, it seems only natural to expect that at least all of their remaining capital expenditure for 2020 will be funded through debt along with their small dividend payments. If operating conditions fail to recover even to their average of the first quarter of 2020, then they will also incur additional debt to cover their negative operating cash flow. Their most recent guidance for capital expenditure during 2020 is C$1.7b at the midpoint. Since C$657m is already attributable to the first quarter of 2020, this indicates that approximately C$1.043b is left for the remainder of 2020 and after including their remaining dividend payments, this can be rounded up to C$1.1b.

Financial Position

Since they face the prospects of incurring additional debt to cover their capital expenditure and now smaller dividend payments, reviewing their financial position will be instrumental in determining their scope to grow their dividend in the future. The three graphs included below summarize their financial position from the last quarter and previous three years.

Image Source: Author.

Whilst they entered this downturn with decent leverage, it has begun rising quickly with their gearing ratio already increasing from 17.80% to 22.10% by the end of the first quarter of 2020. If they are required to fund their aforementioned capital expenditure of C$1.1b through debt, based on my calculations their gearing ratio will reach 27.41% by the end of 2020, which assumes that they see no further impairments.

Although a gearing ratio of approximately 27.41% is not particularly high for large oil and gas companies, since they are relatively smaller they are likely to need to deleverage once conditions recover before growing their dividend. This is especially relevant since their ability to service their debt was already rather stretched during 2017-2019 with an average interest coverage of only 3.87, which is concerning since their net debt would increase 51.48% compared to the end of 2019 to C$5.673b under this scenario.

If they wished to reduce their net debt back to the same point where it was at the end of 2019, it would take them around five years even if they abstained from any dividends and their annual free cash flow surged to twice its average level from 2017-2019. Unless there is a large and sustained oil price rally this seems quite unlikely and thus indicates that shareholders most likely have a long path ahead awaiting for any materially higher dividends.

This scenario assumed that by the start of 2021 operating conditions have returned to approximately the average of 2017-2019 and obviously the longer this recovery takes, the longer it will also take for them to reduce the additional leverage incurred. Considering their industry is facing a secular decline as the world moves away from fossil fuels in the coming decade, it is quite possible that their dividend never returns to any material extent.

Image Source: Author.

Even though their leverage has continued to increase, one bright spot has been that their liquidity has remained solid with current and cash ratios of 1.01 and 0.39 respectively. Given the almost certainty of further negative free cash flow, their cash balance of C$1.322b will come in very handy covering this shortfall. Nonetheless with negative free cash flow likely to exceed C$1b for the remainder of 2020, this will quickly be drained but thankfully they still retain two equal sized credit facilities totaling C$4b that have C$3.401b undrawn.

They have debt maturities throughout 2020 totaling C$1.049b, however, these can be met with their credit facilities. After this point the outlook for their ability to handle debt maturities becomes less clear, since their first credit facility matures in 2022 when they also have another C$706m of debt maturing. Meanwhile their second credit facility matures in 2024, which is the same year they have a further C$1.059b of debt maturing. Given this they will need access to debt markets to refinance their debt maturities and credit facilities. Thankfully they have a couple of years to sort out their debt maturities and thus it appears likely that they can remain a going concern providing that operating conditions recover within the next one to two years.

Conclusion

Even though they reacted fairly quickly to reduce their dividend and thus reduce their financial pain through higher leverage, it still appears unlikely that shareholders will be seeing those old large dividends again. Admittedly if there was a large and sustained boom in oil and gas prices this may change, but realistically it will likely take many years to deleverage and shareholders should also continue monitoring their debt maturities. Since the world is moving away from fossil fuels, their dividend may never return to any material extent and thus I believe that maintaining my neutral rating is appropriate.

Notes: Unless specified otherwise, all figures in this article were taken from Husky Energy's Quarterly Reports, all calculated figures were performed by the author.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.