Energy stocks get a bad rap because they tend to be very cyclical and highly volatile. This criticism is fair. Many energy investors were burned when oil prices (and oil stocks) crashed in 2014 and 2020 (and many other crashes before those).
Energy stocks are risky, but many Canadian stocks are becoming less risky
Energy stocks rely on energy prices. That makes them precarious. However, things are changing, especially in the Canadian market. Returning capital has become more important than growing production. Where debt was used to rapidly grow, it is now being quickly reduced to generate cash returns for shareholders.
Many firms have already established large, multi-year reserve basins. As a result, they can still maintain or grow production at only a limited incremental cost. Since COVID-19, Canadian energy companies have consolidated and reduced their overall cost structure.
Many Canadian energy stocks can generate spare cash, even with oil prices as low as US$50 per barrel (and in some cases even into the mid $30s). With that spare cash, companies are reducing debt, buying back stock, growing base dividends, and paying special dividends.
Canadian Natural Resources (TSX:CNQ) and Tourmaline Oil (TSX:TOU) are two of Canada’s top energy producers. In a sense, they are further along the curve than most other stocks in the sector. They are an image of where the industry is heading.
Canadian Natural Resources: The biggest and the best
Canadian Natural Resources is Canada’s largest energy producer. It has refined its operations with a fine-tooth comb. Its oil sands operations (that make up over 30% of its operations) have a cash flow breakeven of US$25-$35 per barrel.
It has 32 years of reserve life. It can unlock that production at minimal cost. CNQ tends to generate returns that are steadier than many peers. This is largely why Canadian Natural has been able to grow its dividend for 24 consecutive years at a +20% compounded annual growth rate.
Today, CNQ yields a base dividend of 4.5%. It has been known to pay the odd special dividend during a good year, so that could be up for grabs if it continues to reduce its overall debt as well.
Tourmaline: The king of special dividends
Speaking of special dividends, Tourmaline is the king. Tourmaline has a pristine balance sheet with zero net debt. Like Canadian Natural, it has a very lean operating structure.
It can generate significant cash flow, even when natural gas prices are not overly elevated. This is because it has access to some of the best-priced markets in the world. Consequently, it can consistently fetch strong pricing and earn strong cash returns.
Since it has no debt, Tourmaline has been returning extra cash right back to shareholders in the form of special dividends. This year, it paid out $5.50 per share in special dividends.
That equals to an 8.3% dividend yield from the special dividends alone. It also pays a base dividend that equates to an additional 1.56% yield. That’s not a bad return just from dividends alone!
Another energy stock with good potential
These two companies are where much of the sector is heading. Heavy oil stocks like Cenovus Energy are working to get to the same point by aggressively reducing debt.
Once Cenovus hits long-term debt targets (hopefully by mid-2024), it has plans to return 100% of its spare cash back to shareholders in the form of share buybacks or dividends.
If you believe oil can stay in the US$70-90 per barrel range, Canadian energy stocks continue to be a strong place for long-term shareholder income and capital returns.
