Valuing oil and gas stocks is a challenge

Oil and gas stocks are difficult to gauge right now. Uncertainty over the price of oil and forecasts of where prices will be a year or two from now are all over the map. That makes valuing energy stocks challenging. We think Arc Resources has the most reliable dividend among the Money Reporter’s best oil and gas royalty trusts. The company has maintained its dividend through the current energy downturn. And provided that long-term West Texas Intermediate oil rises to exceed $65 in two to four years, we think the prospects are good that it will continue to be maintained. Conservative investors, therefore, may want to favour Arc over other oil & gas income stocks.

Arc Resources Ltd. (TSX─ARX) has reported strong second-quarter results. Its production averaged 109,900 barrels of oil equivalent, or boe, per day for the quarter. Though production was slightly down from the 110,165 boe per day produced in the same quarter of last year, it was nonetheless higher than some analysts’ estimates.

Similarly, the company reported that its funds from operations, or FFO, were $0.61 a share. That was down from $0.93 in the same quarter last year. But the Street had expected the company’s FFO to be just $0.57 in the latest quarter.

Arc is one of Canada’s leading conventional oil and gas companies. Its operations are focused in five core areas across western Canada: northeast B.C., northern Alberta, Pembina, south central Alberta, and southeast Saskatchewan and Manitoba.

Like others in its industry, the company has been unable to escape lower energy prices unscathed. For the six months ended June 30, 2015, Arc’s FFO were $397.8 million, or $1.18 a share, compared with $588.1 million, or $1.86 a share, in the same period of 2014.

Though production increased 6.6 per cent to an average of 115,098 boe per day during the latest period, significantly lower 2015 crude oil and natural gas prices more than offset production gains. On average, the company realized an average price of just US$30.07 a boe, compared with $57.16 in the previous period.

It’s noteworthy that among oil and gas stocks, Arc has maintained its dividend throughout the recent downturn in the energy sector. Arc’s balance sheet remains strong, with long-term debt just 1.6 times annualized cash flow. (We prefer a number under 2.0). This gives the company financial flexibility to withstand low energy prices for now.

The stock trades at a reasonable 8.9 times the $2.25 in cash flow per share it will probably earn in 2015. The current annual dividend of $1.20 a share yields 6.1 per cent. Keep in mind, though, the current dividend may not be sustainable if energy prices remain stubbornly low for long. Arc is a buy for patient investors seeking growth and income.

 

Money Reporter, MPL Communications Inc.
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