PHX Energy Services: Dividend Sustainability Amid Shifting Tides in Energy Markets

PHX Energy Services (TSE:PHX) has long been a stalwart in the energy services sector, leveraging its expertise in drilling equipment and technology to navigate volatile markets. Yet, the question of whether its dividend—currently yielding a robust 9.4%—can remain sustainable, and whether it has growth potential, demands a rigorous analysis of cash flow dynamics, earnings trends, and industry forces.

Cash Flow Coverage: A Mixed Picture

PHX's dividend sustainability hinges on its ability to generate consistent cash flows. In 2024, operating cash flow totaled $96.9 million, nearly flat compared to 2023's $96.7 million. While stable, this masks a concerning trend: the fourth-quarter operating cash flow dropped 52% year-on-year to $17.7 million, signaling potential seasonality or operational challenges.

The funds from operations (FFO) metric, which adds back non-cash expenses, fell 16% to $99.7 million in 2024, with FFO per share dropping 6% to $2.12. This decline reflects higher capital expenditures and weaker high-margin activity. Meanwhile, excess cash flow—FFO minus capital spending—plummeted 49% to $47.6 million, down from $92.8 million in 2023. Despite this, PHX maintained its dividend payments, distributing $37.6 million, a 24% increase over 2023, while repurchasing $20.6 million of shares under its NCIB program.

The payout ratio (dividends divided by FFO) in 2024 was 65.57%, a manageable level. However, the cash flow coverage ratio—operating cash flow divided by dividends—was 2.58x, which is solid but lower than the 2023 ratio of 3.27x. This narrowing margin highlights a growing dependency on stable or improving cash flows to sustain dividends.

Earnings Trajectory: Early Signs of Recovery in 2025

PHX's Q1 2025 results offer cautious optimism. Operating cash flow dipped 2% to $10.9 million, but FFO surged 28% to $33.4 million, with FFO per share rising 33% to $0.73. This improvement suggests cost discipline and higher revenue from its high-margin technologies, such as RSS systems and electric motors.

Excess cash flow soared 144% to $18.2 million, driven by lower capital spending and stronger FFO. This bodes well for 2025's dividend outlook, as Q1's payout of $9.1 million—though 4% below 2024's $9.45 million—was supported by a robust FFO/dividend coverage ratio of 3.67x.

Backtest the performance of PHX.TO when 'buy condition' is triggered on the announcement date of quarterly earnings releases, and 'hold for 20 trading days' after each earnings date, from 2020 to 2025.

However, historical backtesting reveals that a buy-and-hold strategy triggered on earnings announcement dates has underperformed. From 2020 to 2025, such an approach yielded a CAGR of 11% but with a maximum drawdown of -34.41% and an excess return of -33.7%, indicating significant risk.

The dividend per share (DPS) remained flat at $0.20 quarterly, totaling an annualized $0.80. While this stability is reassuring, growth hinges on whether PHX can expand FFO beyond its 2023 levels.

Industry Dynamics: A Cyclical Sector with Tailwinds and Headwinds

The energy services sector remains cyclical, tied to oil prices and drilling activity. PHX's focus on high-margin technologies—such as its advanced drilling equipment—positions it to capture premium pricing, especially as oil majors prioritize efficiency. The global push to modernize aging oilfields and reduce emissions could amplify demand for PHX's solutions.

Yet risks loom. A prolonged oil price slump or geopolitical disruptions—such as trade restrictions on critical minerals—could crimp drilling budgets. Additionally, the sector's capital intensity requires ongoing reinvestment, which may limit dividend growth if earnings stagnate.

Investment Thesis: High Yield with Caution

PHX's dividend offers an attractive yield, far exceeding the energy services sector's average of 3.2%. However, investors must weigh this against the following:

1. Sustainability Risks: The 2024 excess cash flow decline and narrower coverage ratios suggest the dividend is less insulated than before. A further drop in FFO or rise in capex could test its viability.
2. Growth Potential: If PHX can stabilize FFO around $100 million annually and reduce capital spending, the payout ratio could fall to 50-60%, freeing cash for dividend hikes. The Q1 2025 rebound in FFO is a positive signal.
3. Valuation: At a P/E of 10x (assuming $0.44 earnings per share), PHX is undervalued relative to its peers, but this reflects market skepticism about its cash flow stability.

Conclusion: A Dividend Play for the Aggressive Investor

PHX Energy Services presents a compelling opportunity for income-focused investors willing to tolerate cyclical volatility. Its dividend, while sustainable at current levels, requires vigilance around FFO trends and capital allocation.

Actionable Advice:
- Buy: For investors seeking high yields and willing to accept moderate downside risk. Target a 5% yield (price of ~$16.00/share based on $0.80 DPS). However, historical performance of earnings-driven strategies highlights material execution risks.
- Hold: If FFO growth remains stagnant. Monitor Q2 2025 results for clues on the recovery's durability.
- Avoid: If oil prices dip below $70/bbl or the company's excess cash flow falters further.

PHX's dividend is a testament to its financial discipline, but its future growth hinges on navigating an industry in flux. For now, it remains a high-yield bet with potential rewards for those patient enough to ride the sector's cycles.

Disclosure: The analysis assumes no direct knowledge of the author's personal holdings.