Dividend Watch List

NAL Energy Corp (TSX: NAE, OTC: NOIGF) was the only company in the Canadian Edge coverage universe to cut its distribution in January. The reduction to CAD0.05 per share per month from a prior rate of CAD0.07 is the second since the oil and gas producer converted from income trust to corporation in early 2011. It’s also a drop of 73.7 percent from the peak rate of CAD0.19, last paid in November 2006.

Not coincidentally, this rate of reduction corresponds closely to the drop in natural gas prices over the same timeframe. Gas peaked in late 2005 following a multi-year tightening of supplies that reached its apex when hurricanes Katrina and Rita shut in Gulf Coast production capacity.

Since then NAL has systematically worked to reduce its dependence on natural gas output by increasing its production of oil and natural gas liquids (NGLs). Gas, however, was still nearly two-thirds of total output in the third quarter of 2011. And only a radical shift in capital spending toward liquids will push the company toward its goal of garnering half cash flow from oil and NGLs.

The dividend cut was announced during a Jan. 11 guidance conference call, when management also laid out three “primary components” of its financial focus. They are, in the words of CFO Keith Steeves, “maintaining an optimal capital structure, renewing and maintaining an appropriate level of debt…and ensuring we have sustainable cash flow.”

Over the long haul this is a conservative strategy tailor-made for patient dividend investors. In the near term, however, it’s a pretty clear statement that management will continue to sacrifice the current dividend rate in favor of bringing down debt–and, to a lesser extent, to maintain enough capital spending to boost liquids as a percentage of total production. Mr. Steeves confirmed the latter by stating that it’s management’s “intention to continue to show the markets that we can maintain and grow out liquids.”

The cash saved by the dividend cut will be immediately put to work to pay down existing debt, including the maturing convertible debt. Management expects 2012 cash flow to cover more than 90 percent of total dividends plus capital spending. That’s assuming an average price of USD95 per barrel for West Texas Intermediate crude oil, USD3 per million British thermal units at the Alberta hub and an exchange rate of USD0.98 per Canadian dollar. It also anticipates bringing debt-to-cash flow down to 2.2-to-1 (1.4-to-1 excluding convertible debt) at that range of energy prices.

The catch is that gas is currently well below that target level, even as it remains a critical element of NAL’s cash flow. There’s also the potential for rising costs, as the rest of the industry also attempts to shift from gas to oil production. NAL’s reserve life remains lower than that of many producers, just as development costs have been higher in recent quarters.

This raises the distinct possibility we’ll see another dividend cut, should reality turn out less rosy. And while the market was mostly anticipating this one, another would almost certainly send the stock back toward its early 2009 low of less than USD5. CAD80 million of bonds come due on Aug. 31, 2011, and NAL has drawn CAD302.74 million of its CAD550 million credit line, which is up for renewal in April 2012.

Viewed one way, cutting the dividend will probably help the company to roll over this debt. Viewed another, the cut is a clear warning sign of the squeeze this company is in as natural gas has tumbled to its lowest mid-winter price since the 1990s. NAL is in better shape than some gas-focused producers. But that’s hardly a reason for continuing to hold the stock.

With so much uncertainty lingering, my advice remains to sell NAL Energy if you haven’t yet.

The List

Companies land on my roster of companies with endangered dividends for one or more of three reasons:

• The underlying business is weakening enough for the dividend to be at risk. This is typically due to profits lagging the payout, but may also be caused if debt becomes too high to service or roll over.
• A closed-end mutual fund is paying out significantly more in distributions than it’s making with investment income, meaning dividends are being paid with leverage, sales of assets or by returning fund capital to investors.
• Companies are organized to pay distributions as “staple shares,” which are now targeted by the Canadian government for potential new taxes.

Here’s the rest of the Watch List.  Note the list is basically the same as last month, as we’re waiting for fourth-quarter and full-year 2011 earnings releases and guidance calls for 2012. I’ve also noted confirmed and estimated dates for the release of calendar fourth-quarter earnings, following my review of each stock:

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF)–Advice: SELL. This closed-end fund still has the same problem: Its investment income is far less than what it’s paying out in dividends. Sooner or later it’s either going to have to increase investment income or cut the payout, and risks are high it will be the latter.

Management recently launched a “normal course issuer bid” to buy back up to 10 percent of its outstanding units. That will be slightly accretive, given that the closed-end fund has recently traded at discount to net asset value. But that’s not nearly enough to close the gap between the big current yield and the fact that few of its holdings actually pay a dividend.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–Advice: Hold. The good news here is that pulp and paper market prices seem to have firmed up a bit. That’s promising, though a steep slow down in the Euro Zone would almost surely cause a retreat. The company’s major advantages are low operating costs and relative proximity to Asian markets. It also has a solid balance sheet with no debt maturities for 2012. But the high payout ratio means the margin for error is small. Feb. 7 (confirmed)

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Advice: SELL. The key date here looks like it’s going to be Mar. 8. That’s when management has stated it will hold a conference call to discuss financial and operating performance as well as, presumably, future dividend policy.

The dark cloud here is the company’s early December shift in guidance, which introduced a large number of negative factors that had not been mentioned before. The key to how much the company will pay in 2012 and 2013 dividends is basically what kind of damage these factors wind up doing to cash flow. Some investors seem to be speculating whatever cut there is will be relatively minor. But we’re not going to get a real read on what’s going on until Mar. 8 at the earliest. And as long as there’s this much uncertainty, income investors should steer clear. Mar. 8 (confirmed)

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Advice: Hold. This owner of seniors housing, retirement homes and long-term care facilities has nearly earned its exit from the Watch List. Operations on both sides of the border appear to be in good shape, including in the US, where the company now gets around a quarter of cash flow.

Chartwell has also been able to take advantage of low corporate borrowing rates to reduce financing costs. There’s still the matter of CAD75 million in convertible bonds that mature May 1 and CAD10 million drawn on a CAD85 million credit line that must be rolled over by Jun. 24. The company has a market capitalization of CAD1.3 billion and should be easily able to refinance. But until the deed is done I’m keeping the stock on the Watch List. Mar. 1 (confirmed)

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–Advice: Hold. This stock is still pricing in a hefty dividend cut at yield of nearly 17 percent. That’s likely to remain the case until the company’s dispute with Air Canada (TSX: AC/A, OTC: AIDIF) is finally resolved. The latter remains in dire financial straits and continues to lose market share. In fact Chorus is one of the few healthy parts of the enterprise.

The last time the companies negotiated an agreement the result was a big dividend cut for Chorus. It’s hard to imagine anything exceeding the extremely negative expectations now priced into the stock. But until we get clarity Chorus is going to remain on the Dividend Watch List. Feb. 21 (confirmed)

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Advice: Hold. The key issue here is how much the sale of US operations will affect cash flow and whether revenues from Canada are enough to sustain the distribution.

My view is we’ll get a lot of clarity on this issue when fourth-quarter 2011 numbers and 2012 guidance are released, which is expected to happen on or around Mar. 5. I anticipate solid dividend coverage as well as progress rolling over some CAD311 million in debt in 2013. But until we get answers CML will remain on the List. Mar. 5 (estimate)

Data Group Inc (TSX: DGI, OTC: DGPIF)–Advice: Buy @ 4. The company’s conversion to a corporation came and went smoothly–and without the huge dividend cut that had been priced in. Regaining a decent valuation in the long run will depend on Data Group convincing investors it’s not another Yellow Media Inc (TSX: YLO, OTC: YLWPF) in the making.

That company took another step toward oblivion this week, closing its Canpages division. Yellow’s survival looks increasingly doubtful as the print directory business shrinks faster than the digital business grows.

Happily, that’s not yet the case with Data Group, and its stock has rallied sharply since the corporate conversion. Nonetheless, it’s still pricing in a sizeable cut with a yield of nearly 15 percent. That implies substantial upside if there is no cut and numbers show improving cash flow. But until the uncertainty is resolved, the stock belongs on the Watch List. Mar. 2 (estimate)

EnerVest Energy & Oil Sands Total Return Trust (TSX: EOS, OTC: EOSOF)–Advice: SELL. The closed-end fund has been paying its distribution from capital, not investment income, for quite some time. And there are still few stocks in its portfolio that actually pay a sizeable dividend, meaning this is unlikely to change anytime soon.

To be sure, the oil sands region is very much a land of opportunity. But closed-end funds that pay dividends from capital eventually have to cut distributions, or else pay themselves out.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: SELL. The key here is advertising sales, particularly whether they hold at the company’s core newspapers.

My view is the best investors can realistically hope for is a small dividend cut. In a worst-case the company really does become another Yellow Media, as its print business vanishes while it fails to generate substantial growth in the digital operation.

The current yield of a bit over 13 percent is definitely pricing in a dividend cut. The risk is things turn out worse and a larger cut occurs. Conservative investors should stand clear. Mar. 19 (estimate)

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Advice: Hold. The company’s ability to close the CAD49.6 million purchase of new royalty lands is a clear demonstration of financial strength in this environment. Moreover, the 530 barrels of oil equivalent per day output acquired is 90 percent natural gas, demonstrating a great deal of confidence born from being a low cost company with a secure balance sheet.

Unlike the other companies tracked in the Oil and Gas section of How They Rate, Freehold is primarily a collector of royalties rather than an actual producer. That’s both a positive and negative in this difficult environment, as costs are lower but the decision of whether or not to drill lies with those who rent its lands.

The main reason the stock is on the Watch List is that its payout ratio is quite high for such a volatile industry. And we’ve definitely seen some dramatic dividend cuts at Freehold when energy prices have fallen, as they did in late 2008. As a result the stock is likely to stay on the List so long as gas prices remain weak, despite deriving most of its cash flow from oil sales. Mar. 2 (estimate)

GMP Capital Inc (TSX: GMP, GMPXF)–Advice: Hold. This company’s fortunes wax and wane with activity on the Toronto Stock Exchange (TSX), particularly regarding mergers and acquisitions. The main risk here is activity remains depressed as it was in 2011, triggering a dividend cut, as management has warned, if conditions don’t improve.

GMP’s earnings, dividend and share price history are quite volatile, reflecting the exposure to financial market conditions. On the plus side, the company is holding market share. But until market activity clearly takes a turn for the better, the company will remain on the Watch List. Note GMP lost a couple of key advisors in the past month as it shook up management. Mar. 2 (estimate)

NAL Energy Corp (TSX: NAE, OTC: NOIGF)–Advice: SELL. I’m keeping the company on the Watch List for reasons stated above. Feb. 8 (estimate)

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–Advice: SELL. The preliminary numbers for sales and order backlog released in mid-January did show a slight improvement in some areas from third-quarter tallies. But the reduction of order activity year over year clearly shows how strapped the bus manufacturing industry’s key customers are. And it definitely portends worse for 2012 and beyond, as US state and local governments cut their spending.

Management expects a large number of heavy-duty buses will hit retirement the next several years, eventually causing new order activity to rebound. The company also cited a 7.3 percent boost in municipal government tax receipts over the past year as a sign of improvement in munis’ ability to afford new buses. The year-over-year trend in order backlog, however, is down 8.1 percent. Until that reverses there’s little hope of a meaningful rebound in New Flyer’s operations.

And keep in mind the posted yield still doesn’t reflect the projected 50 percent dividend cut. March 21 (estimate)

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF)–Advice: SELL. This closed-end fund has paid all of its distribution in recent quarters from capital. By contrast, investment income remains basically non-existent. There’s been a rebound of sorts in the fund price since the beginning of the year, though it continues to sell for more than a 15 percent premium to net asset value.

The upshot is investors would have done a lot better buying individual stocks.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF)–Advice: SELL. The 80 percent dividend cut since the July 2002 initial public offering is a pretty clear sign producing and marketing decaffeinated coffee isn’t a good business model for paying dividends.

Ten Peaks may be able to maintain the current level of payment this year, if the US dollar doesn’t crash against the Canadian dollar and make its products less competitive. But the long term view on this stock isn’t favorable from a dividend investor’s perspective. Mar. 19 (estimate)

Bay Street Beat

RBC Capital Markets, responding to strong fourth-quarter traffic numbers and a favorable pricing climate, upgraded WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF) to “outperform” this week. WestJet’s load factor improved over the final three months of 2011, offering little sign that the Chapter 11 bankruptcy filing by AMR Corp (OTC: AAMRQ), parent of US legacy carrier American Airlines, is the proverbial “first domino.”

RBC even saw fit to boost its rating on Air Canada (TSX: AC/B, OTC: AIDIF), itself the subject of bankruptcy talk toward the latter half of 2011, to “outperform.” WestJet, which will report fourth-quarter and full-year 2011 results on Feb. 8, now sports an 11-2-0 buy-hold-sell line on Bay Street. Air Canada’s, meanwhile, is 6-5-0.

WestJet paid its first dividend in 2011, a CAD0.05 per share per quarter rate declared in November 2010. The stock has bounced back from CAD10.46 in mid-December to above CAD13.50, but upside based on air traffic trends looks solid from here. Currently yielding 1.5 percent, WestJet is a buy for growth, too.

Shaw Communications (TSX: SJR/B, NYSE: SJR), the only Canadian Edge Portfolio Holding to report thus far this season (the company’s fiscal year runs from Sept. 1 to Aug. 31, making for a somewhat different schedule) inspired 12 analysts to maintain their ratings on the stock, though EVA Dimensions did issue a “downgrade” to “overweight” ahead of the earnings announcement. Seven Bay Street analysts rate the stock a “buy,” seven rate it a “hold” and three call it a “sell.”

Shaw remains a buy under USD22. For more on the company’s fiscal 2012 first quarter, see the Jan. 18 Flash Alert.

Here’s a rundown of buy-hold-sell ratings for each Portfolio Holding, with the average target price among analysts covering the stock in parentheses.

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF) 2–2–2 (CAD33.00)
• Artis REIT (TSX: AX-U, OTC: ARESF) 4–3–0 (CAD15.67)
• Atlantic Power Corp (TSX: ATP, NYSE: AT) 1–4–2 (CAD14.86)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF) 5–2–0 (CAD14.10)
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPUF) 2–3–0 (CAD27.51)
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) 4–6–1 (CAD22.53)
• Cineplex Inc (TSX: CGX, OTC: CPXGF) 2–10–1 (CAD26.75)
• Colabor Inc (TSX: GCL, OTC: COLFF) 2–4–0 (CAD11.25)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) 3–2–0 (CAD20.42)
• Dundee REIT (TSX: D-U, OTC: DRETF) 5–2–0 (CAD37.35)
• EnerCare Inc (TSX: ECI, OTC: CSUWF) 2–2–0 (CAD9.67)
• IBI Group Inc (TSX: IBG, OTC: IBIBF) 9–2–0 (CAD16.35)
• Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) 7–6–1 (CAD10.65)
• Just Energy Group Inc (TSX: JE, OTC: JUSTF) 4–2–0 (CAD13.30)
• Keyera Corp (TSX: KEY, OTC: KEYUF) 6–2–1 (CAD52.00)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF) 5–5–0 (CAD32.59)
• Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF) 5–3–1 (CAD29.68)
• Provident Energy Ltd (TSX: PVE, NYSE: PVX) 4–3–0 (CAD12.34)
• RioCan REIT (TSX: REI-U, OTC: RIOCF) 3–6–0 (CAD27.02)
• Shaw Communications (TSX: SJR/B, NYSE: SJR) 7–7–3 (CAD22.18)
• Student Transportation Inc (TSX: STB, OTC: STUXF) 1–3–1 (CAD7.06)
• TransForce Inc (TSX: TFI, OTC: TFIFF) 9–1–0 (CAD18.94)

Aggressive Holdings

• Acadian Timber Corp (TSX: ADN, OTC: ACAZF) 0–4–0 (CAD10.69)
• Ag Growth International Inc (TSX: AFN, OTC: AGGZF) 2–8–0 (CAD36.89)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF) 10–7–1 (CAD27.45)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) 3–3–0 (CAD16.60)
• Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) 15–6–1 (CAD51.11)
• Enerplus Corp (TSX: ERF, NYSE: ERF) 2–3–1 (CAD27.27)
• Extendicare REIT (TSX: EXE-U, OTC: EXETF) 1–4–0 (CAD8.42)
• Newalta Corp (TSX: NAL, OTC: NWLTF) 9–2–0 (CAD16.25)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) 1–0–0 (CAD8.00)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) 7–2–0 (CAD13.50)
• Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) 17–2–1 (CAD25.73)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) 10–2–1 (CAD26.88)
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) 6–7–0 (CAD13.57)
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF) 7–6–1 (CAD50.62)

Tips on DRIPs

Provident Energy Ltd (TSX: PVE, NYSE: PVX) has suspended its distribution reinvestment (DRIP) and direct stock purchase plans pending completion of the merger transaction between it and Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF).

The combined Pembina-Provident will apply to list on the New York Stock Exchange (NYSE) once the deal is completed, though nothing has been said yet about a DRIP or a direct purchase plan for the company.

US securities laws restrict participation in DRIPs sponsored by foreign companies that don’t register their offering with the Securities and Exchange Commission (SEC). Most plans of Canadian income and royalty trusts that do sponsor DRIPs aren’t registered under the United States Securities Act of 1933, as amended. US investors, therefore, aren’t eligible to participate.

Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) is now the only CE Portfolio Holding allowing US investors to participate in its DRIP. Information about Penn West’s plan is available here.

Penn West and Provident, because they’re listed on the NYSE, opted into US filing and registration requirements. Whether and when a company lists on the NYSE is a matter of how much overhead expense it’s willing to absorb relative to the potential benefits of accessing a new, larger capital market.

Conservative Holding Atlantic Power Corp (TSX: ATP, NYSE: AT), which listed on the NYSE in July 2010, continues to “evaluat[e] options for a Dividend Reinvestment Program” and “hopes to have this option available to shareholders in the future.” NYSE-listed Aggressive Holding Enerplus Corp (TSX: ERF, NYSE: ERF) has a DRIP for Canadian investors but has not opened it to US investors.

Just Energy Group Inc (TSX: JE, NYSE: JE), which recently listed on the NYSE, has a DRIP but as of yet it is not open to US shareholders.

New Portfolio Holding Shaw Communications (TSX: SJR/B, NYSE: SJR) also hasn’t yet made its DRIP available to US investors.

We’ll continue to track Atlantic Power and any other Portfolio Holdings that indicate they’re considering or announce that they will sponsor DRIPs open to US investors.

Companies under How They Rate coverage that sponsor DRIPs open to US investors include:

• Bank of Montreal (TSX: BMO, NYSE: BMO)
• Bank of Nova Scotia (TSX: BNS, NYSE: BNS)
• Baytex Energy Corp (TSX: BTE, NYSE: BTE)
• BCE Inc (TSX: BCE, NYSE: BCE)
• Enbridge Inc (TSX: ENB, NYSE: ENB)
• EnCana Corp (TSX: ECA, NYSE: ECA)
• Nexen Corp (TSX: NXY, NYSE: NXY)
• Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)
• Potash Corp of Saskatchewan (TSX: POT, NYSE: POT)
• Rogers Communications (TSX: RCI/B, NYSE: RCI)
• Royal Bank of Canada (TSX: RY, NYSE: RY)
• Suncor Energy (TSX: SU, NYSE: SU)
• Telus Corp (TSX: T, NYSE: TU)
• Toronto-Dominion Bank (TSX: TD, NYSE: TD)
• TransCanada Corp (TSX: TRP, NYSE: TRP)