The dividend gusher at oil services firms raises questions

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For the companies that service Canada's energy industry, 2012 is fast becoming the year of the big cash giveaway.

In the past few weeks, a dozen drillers, pumpers and other service providers have inaugurated or substantially hiked their dividends, driven by solid financial prospects and investors' unquenchable thirst for yield.

At least four of those dividends are brand new, brought in by CanElson Drilling Inc. , Essential Energy Services Ltd. , Strad Energy Services Ltd. and Savanna Energy Services Corp. Others saw major upgrades, such as Calfrac Well Services Ltd. , which led the recent charge with a fivefold increase to its dividend on Feb. 28.

Some investors are nervous that for a sector vulnerable to wild swings, the payouts can't last. But it has been hard not to notice the impact of Calfrac's move, which helped fuel a 25-per-cent rise in the company's share price over subsequent days.

In a research report released Wednesday, Jeff Fetterly, an analyst with CIBC World Markets Inc., tracked the new payouts and called 2012 "the year of the dividend for energy services."

"What we're seeing now is a higher prioritization of yield, just because we're seeing such a huge voracious appetite for anything yield-based in the market," he said. "Once one guy does it and sees their stock respond positively to it, everyone pays attention."

Burgeoning dividends are nothing new for the services sector, which provides much of the grunt work needed to wrest oil and gas from the ground, from drilling wells to high-pressure pumping of fluids to fracture tough reservoirs. In fact, several years ago, many services companies converted to trusts, some with yields nearing 8 per cent, before government changes imploded the trust model.

But dividends are, in some ways, an odd fit for the services sector, which is vulnerable to dramatic revenue shifts. When oil and gas prices drop, energy companies cut capital spending, which means drilling rigs sit idle. And when the rigs are idle, service revenue shrivels in a hurry.

The new dividends are "a really precarious thing," said Rafi Tahmazian, a senior portfolio manger with Canoe Financial LP. "In my 25 years in the business, it's been feast or famine in this sector."

Some investors are confident companies won't deliver dividend increases they can't sustain.

"It would be highly irresponsible and suicidal for a board to approve a dividend increase and have to cut it months or quarters later," said Eric Nuttall, lead portfolio manager for the Sprott Energy Fund.

Mr. Nuttall is a "huge advocate" of companies returning capital to shareholders "so long as they're not sacrificing their ability to grow." He points to Calfrac's dividend, which is only about 8 per cent of cash flow; others, such as Canyon Energy Services, are below 20 per cent. In an environment where most service companies are light on debt, that's considered reasonable.

Besides, Mr. Nuttall pointed out, the sector didn't have much choice. Although there has been work to go around in oil and oil-like liquids such as propane and ethane, the bargain-basement price of natural gas has stirred market concern about prospects for drillers and related companies. With some activity slowing – Encana Corp., for example, recently cut more than a third from its 2012 spending plans – a dividend may help keep shareholders loyal.

"It's a way for companies that are trying to get interest back into their stocks," Mr. Nuttall said. "And while activity may flat line for a couple of quarters, at least it gives investors reason to stick around and wait for the uptick. They're getting paid to wait."

The companies, meanwhile, say they're just responding to demand.

"We've certainly seen in the energy services space that more companies are paying dividends than not paying dividends," said Andy Pernal, president of Strad Energy Services, which launched a 5.5-cent-per-share quarterly dividend on March 2. "Yield has become front and centre with investors and potential investors."