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Pengrowth Energy: Avoid the 9% Yield

I recently got an email from a reader asking whether Pengrowth Energy Corporation (NYSE:PGH) — a Canadian oil exploration company with a dividend yield just above 9% — is worth his money.

First, let’s talk big-picture about the sector. If you believe a cyclical recovery is in the works over the next few years, then the energy sector might not be a bad place to look. But you have to be willing to take some lumps until that recovery is tangible.

Consider that the vast majority of oil and gas stocks have underperformed for the last few years thanks to soft demand and subsequently soft energy prices — take Exxon Mobil (NYSE:XOM), up just 7% in the past 12 months vs. 18% for the S&P 500 Index as one example, or Canada’s large cap integrated oil company Imperial Oil (NYSE:IMO), which has lost about 11% in the past 12 months.

Of course, with exploration stocks that throw off a big-time dividend yield, you might find a sweetener that makes it worth your while to get in a year or so early. Even if shares flatline, a 9% yield is pretty impressive, right?

On the surface, I’m OK with this argument and I don’t think the strategy is bad. A few energy-related picks I’ve toyed with myself are offshore oil service stock SeaDrill (NYSE:SDRL) and French megacap Total (NYSE:TOT) because of their big yields and relative stability.

But “stability” is the operative word there, and Pengrowth simply doesn’t have it.

For starters, consider that PGH is off almost 40% in the past year and that its dividend was cut from 7 cents monthly to 4 cents in mid-2012. Longer-term, it’s down about 75% since its 2008 highs back when it was paying 22.5 cents a share.

Dig into the stock and you’ll see that declining share price and declining dividends are the order of the day. Not a good sign.

Furthermore, PGH is looking about breakeven this year at best, with a number of analysts projecting a loss in fiscal 2013. That means any dividend payout will surpass total earnings generated in this fiscal year — and that’s a big warning sign for anyone chasing yield.

It’s true that there are decent reserves at Pengrowth, and that the hopes of a cyclical recovery and firmer gas prices may push it back to profitability. The company also has finally closed the gap with its 200-day moving average and remains only a 5% to 10% move away from crossing over the threshold.

But there’s not a lot to be excited about in the near-term or even the medium-term.

If you like small oil stocks with a big dividend, I recommend Seadrill. Its payout is a bit more volatile and unreliable, but add up the last four consecutive paydays and you get an 8.8% yield based on current prices. Furthermore, revenue is slowly creeping up and earnings per share are much more stable. The dividend payout ratio is admittedly a concern and the distributions might roll back if earnings don’t keep pace, but you could take a 40% haircut on your dividends and still enjoy a yield over 5% in SDRL stock. Shares are up 7% in the past 12 months, which underperforms the market but is much better than the steep loss in Pengrowth.

Got a question for me about a stock? Send an email to editor@investorplace.com, drop me a Tweet @JeffReevesIP on Twitter or post to our “Ask InvestorPlace” Facebook feature.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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