Pengrowth Energy Corp: Can You Count on the 12.3% Dividend?

As they say, every grey cloud has a silver lining.

Take the recent sell-off in energy stocks as an example. Sure, some of the higher risk names are down more than 50% compared to highs made during the summer, but as a result dividend yields have spiked. A company like Suncor Energy Inc. used to only yield a little over 2%. Now, thanks to the weakness in the sector, it yields more than 3%. For folks  interested in collecting a dividend over the next few years while the stock slowly recovers, that’s good news.

But for every secure 3% dividend like Suncor’s, there are seemingly four or five different smaller oil stocks with huge dividends, yields approaching 10%, 15%, even 20%. And that’s even after some of these companies have already cut their payouts.

While I don’t trust the vast majority of those dividends, there’s one company that I think has a fighting chance to maintain its eye-popping 12.3% dividend yield throughout 2015, and that’s Pengrowth Energy Corp (TSX: PGF)(NYSE: PGH). Let’s take a closer look at the company.

All about the hedges

There’s one thing that separates Pengrowth from the majority of its peers — the company’s hedging program.

As outlined in the recent third-quarter results, it had 77% of its remaining 2014 production hedged at $95 per barrel, and has 63% of 2015’s production hedged at $94 per barrel. It even has hedges in place going out until 2016, where it has hedged 33% of production at $95.

The company produces approximately 50% oil and 50% natural gas, the latter of which is also hedged, although not to the degree that oil is. Of remaining 2014 production, 59% was hedged at $3.81 per Mcf, while 47% of 2015’s natural gas production is hedged at $3.85 per Mcf.

Let’s assume a pretty pessimistic scenario and say that oil prices only average $60 per barrel in 2015. Based on current hedges, Pengrowth can still average $82 per barrel sold in 2015. Considering how it could also wrangle some operational savings in a low oil price environment, the company looks pretty well positioned over the next 12 months. Even 2016 wouldn’t be a disaster.

Plus, a significant amount of Pengrowth’s production comes from natural gas, which has held up pretty well compared to crude. Since gas is often a byproduct of crude production, it stands to reason that gas production will likely go down as crude production declines, leading to strength in that commodity.

Further, the company’s Lindbergh thermal oil project is scheduled to go online during the first half of 2015, which is projected to add 12,500 boe per day in production. By 2019, Lindbergh is projected to add 50,000 boe to Pengrowth’s daily production, which is a nice bump from today’s production of approximately 73,000 boe.

The risk

If oil recovers in 2015, I think Pengrowth investors are going to be very happy. But what if it doesn’t, and we’re in a world where oil remains between $60 and $70 per barrel for years?

At this point, many of its competitors are taking steps to deleverage. Capital budgets and dividends are getting cut. I’m hearing reports that contractors are being asked to cut rates between 25% and 50%. And yet, Pengrowth plans to take on more debt in 2015, drawing on its unused $1 billion credit facility. This debt will mostly be used to get the next phases of Lindbergh operational.

Right now, Pengrowth has approximately $1.7 billion in long-term debt, compared to $3.4 billion in equity. At this point that looks manageable, but it starts to look pretty dicey once the $1 billion in untapped credit is added on. There’s little doubt that if oil prices remain weak in 2015, the $250 million the company plans to spend on dividends would be better used to pay down debt.

But for 2015, the company’s dividend looks pretty safe. At an $82 per barrel average price, there’s easily enough cash from operations to cover the dividend, plus it has the borrowing power to help fund capital expenditures. I’m not so sure about 2016, but if you’re a believer in oil recovering at some point soon, Pengrowth should be a pretty solid pick.

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Fool contributor Nelson Smith has no position in any stocks mentioned.

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