As I have stated previously, I like high yields and it’s a bonus if they pay monthly.

A few weeks ago I read about Renegade Petroleum moving towards an “income plus growth dividend model”.

Based on a stock price of $2.35, the annual yield would be 9.8%. On Tuesday, Renegade closed at $2.17.

An article in Tuesday’s Financial Post discusses Renegade and a few other companies moving towards paying monthly dividends.

Canadian junior oil and gas companies seem to be reinventing their business plans in order to once again gain access to capital after three producers last week announced they will switch to an income-and-growth model not unlike the former income trusts that dominate the larger-sized intermediate exploration and production companies.

Pinecrest Energy Inc. and Spartan Oil Corp. announced their intent to merge and institute a dividend of approximately 8%, while Whitecap Resources Inc. announced plans to implement a monthly dividend early next year that will yield about 7%.

The announcements come after two others — Twin Butte Energy Ltd. in 2011 and Renegade Petroleum Ltd. earlier this year — also converted into yield-and-growth companies.

A great starting point is to look at a company’s payout ratio, which represents its ability to pay a dividend over the longer term. This is done by taking the planned dividend payment and capital expenditures and dividing by estimated cash flow.

Anything more than 100% means the company will be using debt to pay its dividend to investors. Interestingly, the intermediates on average have had payout ratios above 100% since the federal government’s decision to tax income trusts back in 2006.

We also recommend looking at a company’s balance sheet strength, capital efficiencies, production decline rates, netbacks and hedging activity.

The greater the decline rate and the weaker the capital efficiency, the more money required to maintain production rates, cash flow and, subsequently, the dividend. In addition, the stronger the netback (lower cost structure and higher priced commodities), the easier it is to generate free cash flow and sustain the dividend.

A strong balance sheet also affords a company time to meet its objectives without having to immediately cut its dividend. Finally, commodity hedging is important to minimize the risk of diminished cash flow from a correction in oil and/or natural gas prices.

In conclusion, we think this could end up being a win-win scenario for the sector, because junior producers may now have the option of either growing into dividend companies and raising capital as part of that plan, or selling out to an existing dividend-paying junior producer.

Twin Butte Energy closed Tuesday at $2.80 and a yield of 6.86%

Whitecap Resources …and the announcement.

Whitecap closed Tuesday at $8.48. The yield will be around 7%.

Pinecrest Energy …and their announcement.

Pinecrest closed Tuesday at $1.66. The announcement had a yield of around 8.3% based on a $1.87 stock price.

Just as a I started writing this post, I saw that Pinecrest was downgraded a bit by an analyst.

CIBC World Markets Inc. analyst Adam Gill downgraded his rating of Pinecrest Energy Inc. (CVE: PRY) to “sector performer” from “sector outperformer” and cut his price target to $2 from $2.75.

As was announced last week, Pinecrest and Spartan will merge to form a dividend-paying corporation, Gill noted. The company is expected to keep production flat in 2013 and plans to pay an annual dividend of $0.155 per Pinecrest share, or an 8.7 percent yield for the next applicable 12 months (8.0 percent for 2013).

Overall, the analyst believes that the dividend model makes sense in this sideways commodity price environment, but believes that there are a few issues that make Pinecrest’s model a little more risky than he would like, notably the very high corporate decline rate.

Based on Gill’s estimate, he believes that in order to keep production flat around 9,250 Boe/d, the company will need to invest $165 million (versus management expectations of $130 million), leading to a total payout ratio of 149 percent. This is due to his higher assumed decline and capital efficiency assumptions.

In conjunction with the analyst’s higher-than-group average payout ratio and the steep decline, his net asset value decreases. Lower growth is the main driver of his price target reduction.

Even before this news, I was thinking that Renegade, Twin Butte and Whitecap would be my first choices for consideration.