Is the XCO Dividend Suspension the First of Many?

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After last week’s nearly 13% plunge in oil prices, the commodity is down some 50% off its peak — all told, crude oil prices are at their lowest level since May 2009. Needless to say, energy stocks have followed suit as drilling in much of America’s shale regions has hit critical price points, making some shale formations very unprofitable.

exco185All in all, the broad energy stock benchmark — the Energy Select Sector SPDR (ETF) (XLE) — has managed to lose about 12% this December alone. And on an individual basis, we’re seeing that a few drops in energy stocks are justifiable, with the prolonged downward trend in oil prices actually affecting how some companies operate their businesses and reward shareholders.

Specifically, small-cap producer Exco Resources Inc (XCO) has suspended its once-hefty dividend (it was yielding nearly 9% before the announcement). That prompts the question: Are more dividend cuts on the way?

A Lesson in Caution for Energy Stocks

Like many shale superstars, Exco Resources boasts strong shale assets — in this case, vast acreage located in the Permian Basin, Appalachia and Northern Louisiana and across the Eagle Ford. Unfortunately, like most small-cap energy stocks, XCO is asset-rich but cash-poor. It takes a lot of technology to frack shale, and that technology is quite expensive … and Exco has had trouble extracting those assets without going into hock to do so.

XCO is burdened with a high debt load — its debt-to-equity ratio of 3.63 is well above the industry average. A persistently low price for natural gas for the past few years has also hampered Exco, as natural gas historically has made up the bulk of the company’s production.

But now with oil drifting lower, things have gotten to the point where Exco has decided it needs to preserve cash, and has cut its dividend on XCO stock. Exco chairman Jeff Benjamin said in the press release that the recent decline in oil prices was the main rationale behind the move. Now, XCO will use the cash to help buoy its 2015 capex budget and invest in other properties.

This heavy decline in oil prices will be felt across the energy sector. According to Barclays Capital, the effect works out to be 1-to-1 on revenues and 3-to-2 on net income. So Brent crude’s decline of 30% theoretically could hit some energy stocks’ revenues by 30% and earnings by 45%.

That hurts if you’re Exxon Mobil Corporation (XOM). But it really hurts if you’re Exco or other smaller producers such as Magnum Hunter Resources Corp. (MHR) and Halcón Resources Corporation (HK).

What to Do About Energy Stocks

Exco might or might not survive the downturn in oil prices. (I actually think it’ll get taken private.) But no matter what, expect similar announcements over the next few weeks — everything from dividend cuts to lower capex spending to even a few bankruptcies.

If you’re heavily invested in small- and mid-cap E&P firms, brace yourself for more heartache. The risk to these firms is coming to a head — if oil keeps dropping, more of these companies are going to be negatively impacted.

While it might be too late to sell in some cases, there’s no reason to bottom-fish for winners. The potential profits in Exco (should it survive) will be there in the long term, even if you don’t catch the absolute bottom. XCO’s story will be a multiquarter shakeout, similar to what we saw with natural gas a few years ago.

If you plan on holding, you may want hedge yourself — especially if your positions are large.

As far as the big guys are concerned, you’re probably OK. Energy stocks like XOM and ConocoPhillips (COP) have the cash reserves, economies of scale and asset bases to handle this recent downturn — even if it’s prolonged. As with all boom ‘n’ bust cycles, quality ends up being the real play. Heck, XOM even raised its dividend during the last bust period in domestic energy.

Bottom line: We might be near a bottom. Or it might be just the second or third inning of oil’s rout. Brace yourself for now, and just be ready for when things turn.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2014/12/fienergy-stocks-xco-dividend-cut/.

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