The oil patch, which has been under pressure for years now, got dealt a massive hit to the chin amid the coronavirus crisis, as the demand shock sparked a new low for oil prices that many of us thought was impossible. In an unprecedented move, West Texas Intermediate (WTI) prices briefly fell into negative territory before bouncing back quickly to the teens and gradually moving back to the high US$30 levels, where it sits today.
While it may not be long before oil prices revisit their pre-pandemic normalized levels, as the economy gradually reopens in conjunction with the demand for energy, investors should be wary of some of the more battered plays in the Albertan oil patch, specifically those with swollen dividend yields.
Safe dividends in the oil patch?
In times where the tides go out on the oil patch, it pays dividends to have a strong preference for well-capitalized, well-diversified integrated energy players. But as we found out in early May, when Suncor Energy (TSX:SU)(NYSE:SU) cut its dividend 55% while axing capital spending to shore up cash savings, even the best-in-breed players in the sector are not immune to significant dividend reductions. And with such reductions came a fallout of income investors who view such payout cuts as unforgivable.
Many investors were aware that such a dividend cut was coming for even the best players in the Albertan oil patch following Royal Dutch Shell’s bombshell announcement that it had taken its dividend to the chopping block, sending shares of many energy players plunging in the process.
Dividend cut? No, thanks!
Suncor’s dividend cut was already baked into the stock when Shell announced its dividend reduction. But with a company like Canadian Natural Resources (TSX:CNQ)(NYSE:CNQ) opting to maintain its hefty dividend commitment (currently yielding 7.3%) at a time when the new normal for oil prices could be set at a new low, yield-chasing investors may be looking at amplified downside in CNQ relative to the likes of a Suncor should Canadian Natural Resources’s management team be forced to follow in the footsteps of its bigger brothers at a later date.
If Suncor can cut its dividend, any oil company theoretically could. Suncor could have kept its dividend intact, but management “prudently” chose to rip the band-aid off right after Shell to save $1.5 billion a year.
Since Suncor’s dividend cut, the stock rallied modestly before surrendering all of the gains. Today, SU stock is right where it was when it announced the dividend cut, while shares of CNQ have since moved over 8% higher, as investors are likely of the belief that the company will keep its dividend intact through this crisis in the oil patch.
While I am a fan of Canadian Natural Resources’s liquidity position, I believe that there’s a chance that management will need to revisit its dividend policy should WTI prices fall under pressure again, potentially normalizing in the 20s or teens — prices where no oil stock’s dividend will be viewed as safe over the long run.
If Canadian Natural Resources is forced into a corner where it has to slash its dividend, as Suncor did, I expect CNQ could correct and surrender the gains it had posted relative to Suncor since its cut, as income investors look elsewhere for their dividend fix.
There is a scenario where CNQ’s dividend could make it through this turmoil, as the firm proves its energy peers wrong.
The next thing you know, WTI could be back above US$55, with CNQ contemplating a dividend hike, as management becomes more optimistic about the long-term trajectory for the oil patch. Having oil above US$55 may seem unreasonable in the midst of this pandemic given all the headwinds facing the energy sector, but if this pandemic passes sooner rather than later, don’t think it’s impossible.
For now, CNQ has a shareholder-friendly management team that will likely do everything in its power to insulate shareholders from the hail storm in the oil patch. The dividend commitment is getting heavy, but unless a bear-case scenario pans out, I don’t see Canadian Natural Resources slashing its dividend unless it absolutely has no other course of action.
The post Canadian Natural Resources (TSX:CNQ): How Safe Is the Dividend? appeared first on The Motley Fool Canada.
Fool contributor Joey Frenette has no position in any of the stocks mentioned.
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