Since announcing it would slash its dividend by 50%, onetime darling of Canada’s oil patch Lightstream Resources (TSX:LTS) has seen its share price crater. Ongoing debt problems have undermined investor confidence, forcing the company to focus on strengthening its highly leveraged balance sheet.
At the end of November, the company announced a revised capital plan. The plan included the dividend cut, an asset divestment scheme, and a reduced capital expenditure program. To state the obvious, this combination will significantly impact the company’s short-term performance.
What went wrong?
Once known as Petrobakken, Lightstream is the second-largest landowner in Saskatchewan’s Bakken unconventional light oil play. It also has considerable holdings in the Cardium shale formation in Alberta.
But it’s the company’s ever-growing pile of debt that has brought it to these dire straits. By the end of the third quarter, Lightstream’s debt had doubled year over year to $2.1 billion — a hefty 3x EBITDA and almost 3.5x operating cash flow. Both measures indicate an overleveraged stock that may have difficulty adequately servicing its debt.
Lightstream’s interest expense grew 11% year over year, to just under $36 million, further increasing expenses. Throw in annual capital expenditures of $715 million and dividend payments of $188 million, and you can quickly see how Lightstream was left with a significant cash shortfall. The company was free cash flow negative for the past four years, bringing into question the sustainability of its current operations.
Can Lightstream stop the rot?
As part of Lightstream’s revised capital plan, management has set a goal to reduce debt to a manageable 2x cash flow by 2015. Based on current cash flows, this would require Lightstream to pay down around $700 million of its existing debt.
To achieve this, management has flagged the completion of asset sales totaling $600 million by 2015 and a significant reduction in capex in conjunction with the dividend cut. With management electing to reduce capex by around 25% from projected 2013 levels, the company will generate considerable cost savings of around $200 million.
Not so fast
But there are a number of red flags regarding this plan. Any significant reduction in capex has the potential to reduce production — and, therefore, cash flows. The oil industry is particularly capital-intensive and without sufficient capex, it is impossible to develop existing assets in order to grow production.
It is also unlikely that Lightstream will be able to ensure an orderly sale of non-core assets, because the market is currently saturated with oil and gas assets. It’s a buyers’ market, and Lightstream may be unable to realize the full value of those assets, forcing it to look at more aggressive measures to reduce debt.
What does this mean for investors?
Even with the recent dividend cut, Lightstream still pays a healthy yield of almost 9%. In positive news, there’s been extensive insider buying of late. A quick and dirty look at the stock’s valuation shows something appealing, too — it trades at an enterprise value-to-EBITDA of around 4.
But I believe even the remaining dividend is under threat because with significantly reduced capex, production will at best remain flat and may even decline … further reducing cash flows … and forcing the company to find additional savings.
The difficult market conditions for asset sales also make it likely that Lightstream may not be able to complete its asset sales on schedule or have to accept lower than market valuations. This also points to the fact that it may need to find other means of reducing its debt.
Foolish final thoughts
Lightstream is paying the price for overreaching and overleveraging, although the new capital plan will go some way to restoring market confidence.
It will take some time before it gains traction in a difficult operating environment for asset sales. More unpleasant surprises could be in store for investors.
