Will Canadian Oil Sands Ltd. Cut Its Dividend?

Oil prices have been on a nasty slide for the past few months and the entire energy sector is taking it on the chin. One of the biggest casualties is Canadian Oil Sands Ltd. (TSX: COS).

It has been a rough year for the company’s shareholders. The stock is down nearly 30% in just three months and now trades at a five-year low.

Its hefty $1.40-per-share dividend currently yields more than 8%. At these levels, the warning lights are flashing all over the Street and investors are wondering if the payout is going to get cut. It wouldn’t be the first time. Canadian Oil Sands has a volatile dividend history.

At the beginning of 2006, the quarterly payout was $0.20 per share. By August 2008, it had risen to $1.25. The wheels fell off at this point and the dividend dropped back to $0.15 in 2009. Things got a bit better and investors cheered a series of increases back up to $0.50 by 2010. In 2011, the payout was cut again to $0.35, where it currently sits.

What this tells investors is that the company can’t be trusted to maintain the payout when oil prices fluctuate. Inconsistency is not well received by the Street and Canadian Oil Sands is being punished right now for that reason.

The recent drop in crude prices and the call by analysts for a further slide to $70 in 2015, are only part of Candian Oil Sands’ troubles this year.

In the second quarter Canadian Oil Sands took a huge hit on cash flow due to reduced production at its Syncrude oil sands facility. Year-over-year net income dropped by 20% because two of the company’s cokers were out of action. One shutdown was for planned maintenance. The other was unexpected.

The two cokers are now operating at full capacity again and results for the third quarter should come in much better than Q2.

One other positive for worried investors is the completion of two capital projects that have tied up significant cash flow. The Centrifuge Tailings Management project and the Mildred Lake Mine train replacement are nearing completion. With both set to wrap up by early 2015, investors might escape a dividend cut because the extra cash flow that was being used to fund the work could be available for the quarterly distribution.

The bottom line

If oil prices continue to fall and finally settle below $70, Canadian Oil Sands could trim the dividend payment once again. Its dividend payout ratio is currently above 80%, meaning it doesn’t have a lot of room to absorb lower realized prices for an extended period of time.

New investors should probably avoid the stock until Q3 earnings come out. It is unlikely that a dividend cut will be announced yet, but guidance will be an important gauge to see how cash flow will be affected by current oil prices in the fourth quarter and through 2015.

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Fool contributor Andrew Walker has no position in any stocks mentioned.

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