OMG, look at those dividend yields rise!

There are a couple ways to have your dividend yields rise, at least as a function of market price.

One is that the underlying company raises the dividend.

The second, and what has clearly gone on in the past two weeks, is that market values crater.

I have not seen this volatility in commodity equity pricing since the Covid crisis began. The peak-to-troughs since two short weeks ago has been about 25 to 30% across the board.

There is likely a confluence of events going on which results in the sell-side pressure in these stocks. One is that the momentum trade is obviously broken and funds that have bought these types of stocks on momentum are likely triggering their stops and bailing out. The second is that the fundamental metrics aren’t nearly as good at US$104 oil than it was at US$120 – all things being equal a 15% haircut in oil price will result in a higher percentage drop of cash flows for most oil equities. The third is from cost of capital concerns – money is getting tighter by the day and the easy gains to be harvested are from energy equities. The fourth is the narrative – namely demand destruction via monetary policy-induced recession and a slowdown in spending and consumption.

You add all of this up together, and when everybody decides to hit the sell button at the same time, you get a very sharp price drop as there is not enough bidding to sustain prices.

The cash flow generation currently for all of these companies is still very positive. Most have stated policies of a mix between debt reduction and buybacks/dividends, and as long as the commodity price environment continues it will continue being highly beneficial for shareholders – but never in a straight line up!

Just as an example, Canadian Natural Resources (TSX: CNQ) is slated to generate about $20 billion in free cash flow for the year (about $18/share with a current market price of $65/share) with oil at US$104. Half is slated for debt reduction and half is for dividends and buybacks. Between Q2 to Q4, they should be able to get their debt down to around $7-8 billion by years’ end and buy back another 5% of their own stock or so, along with paying their $0.75/quarterly dividend. Even if oil traded down another 25% of its present price, the buyback wouldn’t be as large but it would still be around another 2-3% of the shares outstanding. Lower prices increase the long-term impact of share buyback programs – assuming the underlying cash generation of the companies are intact, this is a positive for existing shareholders.

Needless to say, however, the last two weeks have felt like the financial equivalent of getting punched in the face! It was bound to happen, but I wasn’t expecting it to be as sharp as it was.