“Killer Bs” Offer Compelling Value

By David Dittman • December 18, 2012 • Canadian Edge Weekly

Canada-based energy producers Baytex Energy Corp (TSX: BTE, NYSE: BTE), Bonterra Energy Corp (TSX: BNE, OTC: BNEFF) and Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) are well off their 2012 highs and currently offer extremely attractive dividend yields.

Aggressive investors looking to lay bets on a successful outcome to “fiscal cliff” negotiations in the US that lifts the cloud of 2013 global growth expectations could to much worse than to look north to these three oil and gas producers.

Baytex, which closed as high as CAD58.87 on the Toronto Stock Exchange (TSX) on Jan. 26, 2012, but changed hands 26 percent lower at CAD43.55 on Dec. 18, reported a 3 percent increase in production for the third quarter. Although funds from operations (FFO) declined 4 percent compared to the third quarter of 2011, on a sequential basis FFO actually grew by 12 percent. The company posted a payout ratio of 57 percent.

With a production mix of 12 percent natural gas and 88 percent oil, Baytex is favorably leveraged from a commodity perspective.

Baytex has been paying CAD0.22 per share per month since January 2012 and has established a solid pattern of raising its dividend since its January 2011 conversion from income trust to corporation.

From October 2003 to December 2005 Baytex paid CAD0.15 per month. It raised the payout to CAD0.18 for the January 2006 through March 2008 payments then boosted again to CAD0.20 for April 2008 as a rapidly rising crude oil price offset the specter of what was then still a coming tax on Canadian income trusts.

Baytex’ payout reached a trust-era high of CAD0.25 per share in July 2008 and stayed there through December 20008. Management cut to CAD0.18 for January and February 2009 before the payout bottomed out at CAD0.12 for March through December 2009.

In January 2010 Baytex paid CAD0.18, and the dividend has been climbing steadily ever since, to CAD0.20 in January 2011 and then to the present level of CAD0.22 in January 2012.

Management plans to boost 2013 capital spending by about 30 percent above 2012, as it ramps up thermal production at its heavy-oil development projects. Production growth is expected to be 6 percent higher, with 75 percent of output weighted to heavy oil.

Baytex is paying a very solid 6.1 percent as of Dec. 18.

Bonterra, which is down 24 percent from its Feb. 9, 2012, annual high as of Dec. 18, reported solid results for the third quarter of 2012, as average production increased 13.2 percent year over year and 10.4 percent quarter over quarter to 6,666 barrels of oil equivalent per day. Nine-month output was 6,381 barrels of oil equivalent per day, up 2.9 percent from 2011.

The company’s average realized price for crude oil during the first nine months of 2012 was USD83.34 per barrel, about 9 percent lower compared to 2011. Lower prices for oil, natural gas liquids (NGLs) and natural gas hit revenue and cash flow from operations by 13.7 percent and 20.2 percent, respectively, but strong production growth and improved operating efficiencies allowed Bonterra to maintain its dividend.

Bonterra’s production was about 69 percent oil and NGLs during the third quarter, 31 percent natural gas.

The payout ratio for the period was 76 percent of funds flow, above management’s target range of 50 percent to 65 percent.

Bonterra was an aggressive distribution raiser during its life as a Canadian income trust, moving from CAD0.14 per unit per month in January 2002 to CAD0.32 per unit per month by mid-2008, with some hiccups in between.

The company ompleted its conversion from income trust to corporation in November 2008, whereupon it scaled back its monthly payout from CAD0.32 in October 2008 to CAD0.26 in November, and then to CAD0.20 in December, CAD0.16 in January 2009, and CAD0.12 in February, March, April and May 2009.

In June 2009 management raised the dividend to CAD0.14, boosting it again in October 2009 to CAD0.16, in January 2010 to CAD0.18, in April 2010 to CAD0.21, in July 2010 to CAD0.22, in January 2011 to CAD0.24 and in May 2011 to CAD0.26. Bonterra’s paying CAD0.26 per on Dec. 31, 2012, to shareholders of record as of Dec. 14.

But new investors will be able to benefit from Bonterra’s latest increase, which is tied to its mid-December 2012 acquisition of Spartan Energy Corp for CAD419 million in shares.

Under terms of the offer, which trumped an earlier bid for Spartan by Pinecrest Inergy Inc (TSX: PRY, OTC: PNCGF), Spartan shareholders will receive 0.1169 Bonterra shares for each Spartan share held. Based on Bonterra’s 30-day average closing price of CAD43.05 the implied price per Spartan share is CAD5.03.

In a statement announcing the friendly tie-up Bonterra management noted that the merged assets will provide “strong strategic value for both groups” of shareholders. The combined company will benefit from “one of the premier light-oil assets concentrated in the Pembina region, which will be comprised of a complimentary production base and a long-term inventory of drilling opportunities that is anticipated to drive future growth.”

Including the Spartan assets management expects average production to rise to 12,000 barrels of oil equivalent per day.

Bonterra is yielding 7.8 percent as of Dec. 18.

Bonavista, off 45 percent from its Jan. 3, 2012, high of CAD26.77, is perhaps the most intriguing at these levels, though not simply because it’s yielding more than 10 percent as of this writing. Bonavista is the most leveraged to natural gas among our “Killer Bees,” with a third-quarter mix of 60 percent gas, 40 percent oil.

Although the short-term outlook is clearly colored gray due to the virtual depression for natural gas over the last four and a half years, Bonavista has a solid set of development projects stacked 10 years deep that ensures production growth for the long term.

A flexible approach to spending on these projects will allow Bonavista to adequately boost output in the near term while holding fire for a time when natural gas economics improve.

Management confirmed the CAD0.12 payout for January 2013, though it is company practice to review the dividend policy on a monthly basis. This process is particularly fraught these days given global economic certainty and the concomitant impact on commodity prices.

During 2012 Bonavista held its dividend steady by cutting its capital expenditure budget, expanding the number of shareholders participating in its dividend reinvestment plan and selling non-core assets to generate cash. Management remains concerned about the persistently low natural gas price and more recent declines for NGLs and oil prices.

The third-quarter payout ratio was 75 percent.

Though it’s budgeted CAD400 million to CAD450 million for CAPEX for 2013, this could change with commodity prices and the corresponding impact on its growth-and-income model. The 2013 CAPEX budget implies about a 13 percent increase from 2012.

Current debt of approximately CAD950 million is well within the company’s limit of CAD1.55 billion. Bonavista has traditionally carried a higher debt burden than its peers, so a debt-to-assets ratio of 28 percent (compared to 25 percent for Baytex and 19 percent for Bonterra, for example) is little cause for worry.

Third-quarter production was down 9 percent to 65,464 barrels of oil equivalent per day due to asset sales, reduced recoveries from third-party facilities and natural gas reductions. Natural gas and oil production both decreased 11 percent, while NGLs was basically flat.

Production revenue was down 29 percent to CAD188.6 million due to lower commodity prices

And lower production volumes. Third-quarter natural gas prices were down 38 percent, crude oil was 3 percent lower and NGLs were off 26 percent.

Bonavista has been paying CAD0.12 per share per month since February 2011. It converted from income trust to corporation in January 2011, when it reduced its monthly payout from CAD0.16. The payout reached a trust-era peak of CAD0.33 per in October 2006 before management cut to CAD0.30 in November 2006.

It maintained this level until February 2009, by which time natural gas had fallen from above USD13.30 in July 2008 to below USD4.30 and Bonavista reduced its distribution to CAD0.20. From there it went to CAD0.16 in April 2009 and then to CAD0.12 upon conversion in February 2011.

With a yield of 10.2 percent as of Dec. 18 Bonavista is priced for a dividend cut that doesn’t seem likely.

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