An oil and gas stock to buy

Management’s decision to cut capital expenditures is disappointing. But this oil and gas stock’s value is still there.

Lower commodity prices have weighed on the shares of oil and gas stocks in recent months. Stocks heavily weighted to natural gas have been particularly hard hit, with the price for this commodity down about 17 per cent since the beginning of the year.

oil-and-gas-stock

Natural gas prices are down about 17 per cent since the beginning of the year, weighing on such stocks as Arc Resources.

Arc Resources Ltd. (TSX—ARX) is one such stock. And it hasn’t helped that the company has responded to lower commodity prices by reducing its planned capital expenditures. On June 20, it announced it will reduce its capital expenditure program for 2019 by 10 per cent to $700 million, and its 2020 program by 22 per cent.

Calgary-headquartered Arc Resources is one of Canada’s largest oil and gas companies. About three-quarters of its production is natural gas. The company’s operations are focused in the Montney region in Alberta and northeast BC, and the Pembina Cardium region in Alberta. Montney is considered a key growth area with great potential for continued reserves and production additions, while Pembina is one of the largest, most prolific conventional oil fields in Alberta.

Arc’s cutback is prudent

Management has described its decision to reduce expenditures as follows: “Arc’s reduced capital investment levels are consistent with our long-held principles of stewarding low debt, sustainable dividends, and investing capital when it is profitable to do so.”

Given these considerations, we view Arc’s decision as prudent. Its net-debt-to-cash-flow ratio is forecast to be 1.4 by the end of this year. This is well within our comfort zone of no more than 2.0, giving us confidence the company will be able to adequately manage its debt.

As for the monthly dividend, management remains committed to maintaining it at its current $0.05 a share. This amounts to a reasonable 27 per cent of forecasted 2019 funds from operations of $2.20 a share. A reduction in capital expenditures will help the company maintain the current dividend. But, though we don’t foresee a dividend cut in the near term, commodity prices are fickle, and a substantial, unexpected decline could alter the situation dramatically.

Attachie West delay is a disappointment

Another thing Arc wants to do by cutting capital expenditures is to live within its means and invest only when it is profitable to do so. By reducing capital expenditures, the company increases the chance it will be able to at least nearly fund its spending and dividend payments out of its own cash flows this year.

So while the reduced spending plan is a disappointment in that it will delay Arc’s Attachie West Phase 1 project in the Montney region—a project that is regarded to have great potential—it’s a sensible move that shows the company is being responsibly managed.

It also reinforces our confidence that management will be able to successfully execute on such projects in the years to come. Yielding over 9 per cent, Arc is a buy for its strong total return potential if you can tolerate the uncertainty of volatile commodity prices.

This is an edited version of an article that was originally published for subscribers in the July 19, 2019, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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