Is Penn West Petroleum Ltd’s Massive 11.6% Dividend Safe?

Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) has a whopper of a dividend. Can you count on it?

It hasn’t been a good, oh, decade to be a shareholder of Penn West Petroleum Ltd. (TSX: PWT)(NYSE: PWE).

The company has been plagued with lackluster results, poor management, overpaying for acquisitions, a dividend cut, and even an accounting scandal. Because of all this, shares have been among the worst performers on the TSX, cratering 47% during the last year and 93% since 2004.

It’s easy to see why some investors are eager to throw their hands up and be rid of such a terrible company from their portfolios. I can’t imagine anybody being happy after losing 93% of their capital, plus suffering through a dividend cut. But partly due to this sentiment, value investors are starting to sniff around the name, myself included.

We see things like a company that’s trading at a massive discount to book value. Once you strip out its goodwill, Penn West has a book value of $11.31 per share, a huge premium to its share price, which is $4.81 as I write this. It’s also selling off assets to pay down its debt, most of which isn’t due until 2019. Plus, the company thinks production will actually increase in 2015, after years of declines due to asset sales.

Penn West also pays a $0.14 per share quarterly dividend, which is a downright succulent 11.6% yield. Double digit yields are usually pretty risky. Let’s see if the company can maintain it going forward.

Current outlook

Penn West released quarterly earnings last week, which looked to be pretty good. Even though the company lost $0.03/share, it still had a healthy funds flow of $0.47 per share.

Included with the quarterly results was a preliminary look forward to 2015. The company stated that based on oil prices of $86.50 per barrel (in Canadian Dollars) and an exchange rate of $1.04 between the Canadian Dollar and the U.S. Greenback, it projects 2015 funds flow to be between $875 and $925 million, while spending approximately $840 million in capital expenditures. That leaves it with between $35 and $85 million to pay its dividend.

If the company pays out its dividend in all cash, it would pay approximately $277 million annually. But like many other companies in the energy sector, it gives investors a discount to take the dividend in shares. Based on historical rates, approximately 20% of investors take their dividends in the form of additional shares. Thus, Penn West would still be on the hook for $220 million worth of cash dividends. Based on the $35 to $85 million in cash flow projected, Penn West would either have to cut the dividend or borrow to pay it.

Digging deeper

You could argue that Penn West was overly conservative for its 2015 projections. It assumed an exchange rate of $1.04, even though currently 1 U.S. Dollar will buy you $1.13 Canadian. Does it look any better based on current rates?

Yes, but not enough to make up the difference. The 8.6% difference adds between $3 million and $8 million to Penn West’s projected 2015 cash flow. That’s not nearly enough to make up the difference.

There are two things that could happen to ensure Penn West can pay its dividend. Either oil prices have to recover, or it has to drastically slash its capital expenditures. The latter could happen, but I wouldn’t count on it. The company has a conference call scheduled next week to give investors more details on its plans for 2015, which I’m guessing will involve a modest cut in capex, but that’s it.

What will happen to the dividend? It’s obvious that if oil prices stay depressed Penn West will be unable to pay it and continue its capital expenditures. Something has to give. Considering how depressed the stock is, I suspect management will use this opportunity to cut or even eliminate the dividend. The $220 million slated to go to investors could be better used paying off the debt or investing in future growth.

There are plenty of reasons to buy Penn West. The dividend isn’t one of them. If you’re looking for more consistent dividend income, we have 3 top picks. Check them out below.

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 Nelson Smith has no position in any stocks mentioned.

More on Dividend Stocks

Payday ringed on a calendar
Dividend Stocks

TFSA Monthly Money: How to Generate Consistent Tax-Free Passive Income

Adding these two attractive Canadian dividend stocks to your TFSA now could help you earn reliable monthly passive income for…

Read more »

analyze data
Dividend Stocks

3 Magnificent TSX Dividend Stocks to Buy and Hold Forever

Do you want to hold some quality dividend stocks for the decades ahead? Here are three stocks worth holding for…

Read more »

HIGH VOLTAGE ELECRICITY TOWERS
Dividend Stocks

How Much Will Canadian Utilities Pay in Dividends This Year?

Investors can stabilize their long-term stock portfolio returns by accumulating quality utility stocks on meaningful dips.

Read more »

edit Real Estate Investment Trust REIT on double exsposure business background.
Dividend Stocks

The 3 Top Canadian REITs to Buy in May 2024

These REITs in strong sectors are well-positioned to deliver passive income through regular dividend payments.

Read more »

Family relationship with bond and care
Dividend Stocks

Dividend Investors Can Earn $500 Every Month or More With the Right Stock Offering a 6% Yield

Two high-yield monthly income stocks are attractive options for dividend investors, including retirees.

Read more »

Question marks in a pile
Dividend Stocks

Down 14%: Is This Toymaker Stock a Good Buy in MAY 2024?

The right time to buy a discounted stock can be difficult to pin down, especially when there are no clear…

Read more »

Various Canadian dollars in gray pants pocket
Dividend Stocks

2 Dividend Stocks That Could Create $2,484.40 in Passive Income in 2024

These two passive-income stocks offer not just dividends but returns as well! And should continue to do so for at…

Read more »

lab worker inspects test tubes
Dividend Stocks

Time to Pounce: 2 Ultra-High-Yield S&P 500 Dividend Stocks That Are Screaming Buys Right Now

More than a dozen S&P 500 components sport "ultra-high yields." Two of these time-tested titans are begging to be bought…

Read more »