If the Bank of Canada hikes the overnight rate target, it will increase the borrowing costs of businesses. That said, companies with low debt levels can more easily adapt to a rising interest rate environment.
With flexible balance sheets, and especially if energy prices improve, the following energy stocks will have amazing upside. One even offers a +10% dividend yield.
Let’s explore these energy stocks and determine if they can maintain their dividends.
Torc Oil and Gas Ltd. (TSX:TOG) focuses on light-oil assets with sustainable growth. The Canadian Pension Plan Investment Board and insiders of the company own 25% and 4%, respectively, of Torc, which gives the company a strong vote of confidence.
Moreover, Torc has a strong balance sheet and a debt/cap of ~12%. Assuming a WTI oil price of US$45, management expects a total payout ratio of 95% — that is the payout ratio after accounting for maintenance and growth, capital spending, and the dividend. This equates to a net debt/cash flow of 1.6 times, which implies Torc has a stronger financial position than its peers.
At the end of the second quarter, Torc had $242 million of net debt, while it had $400 million of bank facility, of which 51% was undrawn.
At $5.26 per share, Torc offers a yield of ~4.5% and upside potential of 61% in the next 12 months according to the mean target from Thomson Reuters.
Cardinal Energy Ltd. (TSX: CJ) is an oil-focused producer. Cardinal has a debt/cap of ~25%. In June, the company raised gross proceeds of ~$170 million via an equity offering at essentially $5.50 per share for a light oil acquisition of $297 million.
Cardinal increased its credit facilities to $325 million in to raise the remaining funds needed for the acquisition. At the end of the second quarter, Cardinal had $233 million of bank debt. The producer plans to repay some of that by selling some royalty interests and fee title lands.
Assuming a WTI oil price of US$47.50, management expects its adjusted funds flow to reduce in the second half of the year. To ensure its total payout ratio is less than 100%, management has decided to reduce its capital spending by $8 million. This sounds like management is willing to pare down some growth to keep the dividend safe.
At $4.04 per share, Cardinal trades at a 26% discount to its recent equity offering, offers a yield of +10%, and, according to Reuters, has upside potential of 72% in the next 12 months.
Investor takeaway
Between the two oil-weighted producers, Torc will fare better as interest rates rise because it has a stronger balance sheet. Moreover, Torc can maintain a total payout ratio of less than 100% in a US$45 WTI environment. That said, Cardinal management seems committed to maintaining its dividend.
Both companies should do fine if we get US$50 WTI. With the WTI oil price hovering at ~US$48.50 per barrel, though, it’d be a safer investment to go with Torc and get a lower yield of ~4.5%.
More speculative accounts can consider a smaller position in Cardinal. For both companies, don’t expect a huge comeback soon, but be ready to hold for the next three to five years.
