Will Penn West Petroleum Ltd. Bring Back its Dividend in 2016?

After a long history of paying dividends, Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) suspended its payout last year to conserve cash.

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Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) used to be one of the dividend darlings of the Canadian oil patch. However, with oil prices in a free fall and its balance sheet loaded with debt, the company really had no choice but to first reduce and then suspend its payout to redirect its dwindling cash flow to its balance sheet.

Given that the oil price and its balance sheet are the two factors leading to the dividend suspension, if both problems are corrected in 2016 the company could once again return cash to shareholders.

Awakened by a crude reality

Penn West never expected crude oil prices to drop, nor did it see oil falling to the level where it’s currently trading. While it wasn’t the only company that was caught by surprise, it was one of the most bullish oil companies on the price of oil before the price started to head south in mid-2014.

In fact, the company made a bold bet on crude in July 2014 by letting its oil hedges expire, so it could capture the additional $10 per barrel difference between its hedge price and the market price. Unfortunately for the company, that upside didn’t last very long; the price of crude started its descent later that month.

That move cost the company a lot of money and was one of the reasons why the dividend was suspended. While Penn West has since learned its lesson and is hedging again, it still only targets to have 25-40% of its oil production hedged.

That leaves the company exposed if crude keeps falling; however, it’s still pretty wide open to the upside should oil prices rally. Such a rally would fuel a rise in Penn West’s cash flow, which is what’s needed to return cash to investors.

The balance sheet continues to get better

Penn West Petroleum’s other concern, the balance sheet, has improved mightily over the past few years. The company lopped off nearly a third of its debt since oil prices went south in mid-2014. The bulk that that improvement has been fueled by non-core asset sales, which totaled $810 million last year, surpassing its $650 million target. Additional asset sales are likely as the company has designated 26,000 BOE/d of its 82,198 BOE/d of production as non-core.

Despite all this progress, Penn West still has more than $2 billion in debt, which results in a worrisome 4.3 times debt-to-EBITDA ratio. Suffice it to say, the company needs to continue to unload non-core assets in order to whittle down its debt.

That said, with $400 million in recent non-core asset proceeds and just $530 million of debt maturities through 2017, it has bought itself a lot of time. Its next hurdle will be to sell enough assets to cover the rest of that balance as well as to begin to address its $456 million in 2018 debt maturities. If it can address those concerns either through asset sales or debt exchanges, then it will remove a big weight holding back the dividend.

Investor takeaway

For Penn West’s dividend to return in 2016, the company needs oil prices to rebound sharply and ideally be above $60 per barrel. In addition to that the company needs to find solutions to address its upcoming debt maturities in order to remove that weight from the balance sheet. If both happen in 2016 then it’s possible that the company will resume paying a dividend in 2016, though it will be years before it regains its formerly lofty level.

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 Matt DiLallo has no position in any stocks mentioned.

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