Pengrowth Energy reported earnings after the market close Wednesday. Earnings and cash flow fell, and uncertainty over the sustainability of the dividend persisted. The firm is once again in the position of requiring additional divestitures or making a dividend cut within the upcoming year.

The problem for Pengrowth is that the continued payment of the dividend, combined with net losses, is eating into its book equity and, we believe, placing the firm in jeopardy of violating its debt/total capital covenant, which mandates debt cannot exceed 50%. The firm reported a CAD 66 million loss (CAD 0.13 per share) for the quarter, dead on our estimate, and paid out an additional CAD 61.5 million in cash dividends.

By the first quarter of 2014, analysts expect the firm’s debt/total capital to breach 50%, due to lower book equity combined with short-term borrowing to fund the difference between operating cash flow and capital spending. We forecast operating cash flow of CAD 505 million versus CAD 722 million of capital spending in 2013.

The firm’s choices are asset sales or a dividend cut; we would prefer both. The sale of the Weyburn property over the latest quarter helped the firm’s cash position, allowing for the repayment of CAD 160 million of long-term debt, but was not a long-term solution. We also think additional equity issuance would be short-sighted, creating more new shares on which the company would pay dividends. Since there is no guarantee of a buyer for divestitures, analysts think a dividend cut or elimination is the best long-term solution for shareholders.