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Is This Canada’s Next Dividend Champion?

oil sand miningFor years, Canadian Natural Resources  (TSX: CNQ)(NYSE: CNQ) has been a favourite of growth investors chasing the company’s oil sands expansion.

Buoyed by rising oil sands production, Canadian Natural Resources has boosted its payout at a 27% compounded annual clip over the past decade, during which time the dividend has grown elevenfold. Lately, the hikes are getting even bigger. The most recent increase in May was more than 12.5%, a sign that management sees more good things ahead.

Admittedly, the company’s 2% yield might not be high enough to whet the appetite of the most discerning income investors. But given the company’s solid growth prospects, that payout will almost certainly continue to rise. For long-term investors who aren’t spooked by volatile oil prices, the stock could produce some handsome returns.

Canadian Natural Resources has a number of things going for it. It has one of the largest land bases of any energy company in the country, the best growth profile in the North American large-cap energy space, and higher prices for its oil sands bitumen.

Over the past decade, the company spent tens of billions of dollars to fund its oil sands expansion. Now that the firm’s main Horizon mega-project is nearing completion, most of those expenses are in the past. Bitumen is coming out of the ground, rather than just cash going into the ground.

The company’s first-quarter results highlight this trend. Adjusted earnings — which strips out a number of one-time items — more than doubled to $921 million, or $0.80 per share. Solid production growth and strong energy prices led to a 20% increase in cash flow over the fourth quarter of 2013.

That trend is expected to continue. Based on current commodity prices, management projects free cash flow to grow fivefold by 2018 to $5.5 billion. All of that is likely to be returned to shareholders in the form of rising dividends and share buybacks.

Not everyone is optimistic. Without the approval of TransCanada’s (TSX: TRP)(NYSE: TRP) Keystone XL pipeline, the discount for oil sands bitumen could increase. Cost inflation, especially for labour and materials, is always a looming threat.

However, even without the Keystone XL pipeline, bitumen is finding a way to buyers. Enbridge  (TSX: ENB)(NYSE: ENB), Canada’s top oil shipper, has plans to quietly add one million barrels per day of export capacity over the next few years. These initiatives include clearing bottlenecks in the Chicago area, twinning the Spearhead and Seaway pipelines, and reversing its Line 9 route.

There are other exit avenues as well. Last year, TransCanada started pushing forward on its new Energy East proposal, which, if approved, would single-handedly replace Keystone. Shipping crude by rail has also emerged as an effective stop-gap until new pipeline capacity is built.

It’s also apparent that oil sands players have learned from their past mistakes, when rampant spending blew out development budgets. Suncor  (TSX: SU)(NYSE: SU) has dialed back its expansion plans. Instead, the company has chosen less ostentatious debottle-necking initiatives — industry slang for wringing more production out of existing operations — to grow production rather than opening new mines.

Rivals Cenovus  (TSX: CVE)(NYSE: CVE) and Imperial Oil  (TSX: IMO)(NYSE: IMO) have also adjusted their strategies. Rather than commence dozens of mega-projects in one go, these management teams are opting to stagger the construction of new mines and roll out projects in stages. This should help keep the cost of labour and materials down in the future.

The risks aside, I think Canadian Natural Resources is going to become a cash flow machine. While the stock’s yield might be unimpressive today, investors can count on a number of large distribution hikes and share buybacks in the years to come.

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