Is Whitecap Resources’s (TSX:WCP) Monster 8% Yield Safe?

Buy Whitecap Resources Inc. (TSX:WCP) today and lock in an 8% yield.

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The energy patch has fallen into disfavour with investors and even the latest oil rally, which sees West Texas Intermediate (WTI) trading at over US$60 a barrel, has done little to lift Canadian energy stocks. One upstream intermediate producer that has been attracting considerable attention is Whitecap Resources (TSX:WCP). It has only gained a modest 3% since the start of 2019 compared to oil’s 30%.

The driller, however, because its stock has failed to recover, is sporting a very juicy 8% dividend yield. The size of the yield has sparked considerable speculation among market pundits that the dividend is not sustainable and a cut may be looming. This is despite Whitecap hiking its monthly dividend by 5.6% at the end of the first quarter 2019.

Let’s take a closer look at whether the dividend truly is under threat and whether Whitecap should trim the payment.

Is the dividend sustainable?

A traditional measure of dividend sustainability is its payout ratio as a proportion of net income. When applying this measure, the payment has a trailing 12-month payout ratio of 640% on a diluted basis, indicating that it is clearly unsustainable, and that Whitecap should essentially eliminate the dividend.

However, this is not the only means to measure the sustainability of a dividend and may not be the most appropriate because of the capital-intensive nature of the oil industry.

A better means of testing sustainability is to find the payout ratio as a function of funds from operation (FFO). On a trailing 12-month and diluted-per-share basis, the dividend represents a mere 19% of Whitecap’s FFO, illustrating that it is indeed sustainable.

If we turn to the driller’s full-year 2019 guidance, where it predicts FFO of $1.66 per share diluted and allows for the recent dividend hike (the annual dividend is $0.342), the payout ratio should settle at around 21% of FFO. This is based on WTI averaging US$60 a barrel over the course of 2019 and illustrates that the dividend can be maintained. Should WTI weaken again and average US$55 a barrel, FFO will fall to $1.55 per share diluted, which equates to a payout ratio rising only slightly to a very sustainable 22%.

Whitecap has also established hedges to provide a price floor for 42% of its second-half 2019 production. Those hedges, along with considerable liquidity totalling $570 million and the ability to dial down capital spending as required, further enhances the sustainability of Whitecap’s dividend.

Why buy now?

What makes the driller an even more compelling buy is that its copious oil reserves totalling 423 million barrels net after royalties have an after-tax net asset value (NAV) of $9.98 per share, which is more than double its current market value. That underscores the considerable upside available to investors should oil rally for a sustained period, and when oil finally recovers, Whitecap could double or more in value. While they wait for that to occur, they will profit from Whitecap’s sustainable dividend yielding a monster 8%, which is a more than adequate reward for the risk associated with investing in the upstream oil producer.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any of the stocks mentioned.

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