Encana’s Dividend Looks Unsustainable - They're Not Alone

Encana’s Dividend Looks Unsustainable – They’re Not Alone

Canadian energy stocks are paying out way more than they should be. Find out which 4 companies are the best of a bad bunch.

Iain Butler ❯

Chief Investment Advisor, Motley Fool Canada Fool since November 2012 Iain Butler, CFA, is Lead Advisor on Discovery Canada 2017. He is also the Chief Investment Advisor for Motley Fool Canada and is the lead advisor on its flagship Stock Advisor Canada product. Before joining the Fool, Iain was a “buy-side” analyst and through this experience is well-versed in the idiosyncratic ways of the Canadian market. His investing interests are centred on scouring the market for interesting businesses that trade at reasonable prices and offer an appealing risk/reward relationship. Since joining the Fool in 2012, Iain dedicates each day to spreading Foolishness throughout this great country!

Published May 13, 2013 10:48 am EDT

A recent piece in the Wall Street Journal indicated that because of Encana’s (TSX:ECA) high payout rate, the company’s dividend could be “a casualty of any strategy shake-up” once the company finally hires a new CEO.

In my mind, this assessment is bang on.

Encana’s $588 million dividend payout represented about 20% of last year’s cash from operations (CFO). And, the company generated negative free cash flow (CFO – capital expenditures) of about $500 million over the past 12 months. This means the dividend is effectively being paid by issuing debt. Not a sustainable formula.

There’s more

The scariest part of this story is that ECA is not the only one of its Canadian peers that’s paying out a high proportion of its operating cash flow in dividends. According to Capital IQ, of the 21 energy producing companies in the S&P/TSX Composite that pay a dividend, the average payout from operating cash flow was 28% over the past 12 months. At 20%, Encana looks relatively good!

The WSJ article indicates that most E&P companies payout 5% of their operating cash in dividends. We’ll assume their sample was U.S. based as none of the Canadian energy producers met this 5% level.

Tabled below are the 4 seemingly most sustainable dividends in Canada’s energy patch based on payout in relation to operating cash flow over the past 12 months.

Company Name	Market Cap	Payout Rate	Dividend Yield
Petrominerales (TSX:PMG)	$497	6.5%	8.5%
Pacific Rubiales Energy (TSX:PRE)	$6,948	7.2%	2.1%
Cdn Natural Resources (TSX:CNQ)	$32,683	7.8%	1.7%
Whitecap Resources (TSX:WCP)	$1,406	9.8%	5.8%

Source: Capital IQ

Foolish Takeaway

If you’re an investor in Canada’s energy patch and are reliant on dividend cheques from this space, you need to be wary of this issue. It’s worth your while to review your holdings and examine their cash flows to get a sense for how sustainable these payouts actually are.

We have created a special FREE report that profiles a collection of rock-solid dividend paying stocks whose payouts are more than affordable. Click here and we’ll send you “13 High-Yielding Stocks to Buy Today” – FREE!

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Fool contributor Iain Butler does not own any of the companies mentioned in this report at this time. The Motley Fool has no positions in the stocks mentioned above.