CVX, XOM: Oil dividends that can survive plunging prices

CVX, XOM: Oil dividends that can survive plunging prices

For many decades, Big Oil investors have been richly rewarded by hefty dividend checks from the likes of Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX). Both Exxon and Chevron are members of the exclusive Dividend Aristocrats list, a group of stocks that have raised their dividend payouts for at least 25 years.

But due to the steep collapse in oil prices over the past two years, there is a trend of dividend cuts sweeping through the oil patch. Investors are increasingly nervous that after a 70 percent peak-to-trough decline in the price of oil, high-yield dividend stocks in the energy sector won’t be able to maintain their generous distributions. Companies of all sorts have cut their dividends, including Kinder Morgan (NYSE: KMI), and more recently, ConocoPhillips (NYSE: COP). What’s worse, companies that have been even harder-hit, specifically exploration and production firms and offshore rig operators, have had to eliminate their dividends entirely just to stay afloat.

Dividends are disappearing left and right, and the takeaway for investors is to focus on the most financially sound companies with diversified business models, like Exxon and Chevron, as these may be the only companies equipped to maintain their dividends at $30 oil.

Big Oil takes a beating

Not surprisingly, the reason for so many dividend cuts is because fundamentals have deteriorated rapidly alongside the massive decline in commodity prices. As WTI crude drops, profitability shrinks. Making matters worse for many oil companies is that because they loaded up on debt to fund acreage purchases, acquisitions, and expanding production, their balance sheets are stretched. The massive ramp-up in domestic production left many companies saddled with over-leveraged balance sheets, and the irony is the increasing production directly contributed to the crash in oil prices.

The latest example is ConocoPhillips, which cut its dividend by 66 percent on Feb. 4, due to its mounting losses. ConocoPhillips lost $3.5 billion in the fourth quarter alone -- a loss of $2.78 per share for the quarter when analysts expected a loss of just $0.65 per share. For the full year 2015, the loss was $3.58 per share. Therefore, it is not surprising that the company finally cut its dividend. It had tried to cut costs and sell off assets to raise the necessary cash to maintain its dividend. These measures included a 14 percent reduction in 2015 capital expenditures and $2 billion of asset sales for the year. But these actions could only accomplish so much. No company losing money for this long can continue to maintain its dividend forever.

The takeaway is that when oil prices slide, most companies have nowhere to hide. However, not all companies are doomed to the same degree. Exxon Mobil and Chevron are two examples of companies that have been able to maintain their dividends, throughout the crisis.

These two dividends can make it through

Exxon Mobil and Chevron shares have fallen significantly over the past year. As stock prices and dividend yields are inversely related, this has pushed up their dividend yields to levels well below their historical averages.

Exxon Mobil’s yield exceeds 3.5 percent, while Chevron yields almost 5 percent. These high yields are normally a red flag—indicating that investors have sold the stocks because they do not feel confident in the sustainability of those payouts.

And yet, both Exxon Mobil and Chevron have maintained their dividends thus far, while so many rivals in the oil sector have not. The reason why is two-fold: first, they have the largest operations and have squeezed out huge cost cuts. This has allowed them to weather the storm much better than smaller competitors. Separately, Exxon Mobil and Chevron have the strongest balance sheets in the sector, a direct benefit from their integrated operations.

Exxon Mobil and Chevron are known as integrated majors, meaning they have upstream exploration and production businesses, and also downstream refining businesses. Their balanced business models provide valuable insulation against huge declines in the price of oil, because refining actually performs better when oil prices fall. That’s because lower oil prices mean lower refining feedstock costs, which widens refining profit margins. Refining helped Exxon Mobil and Chevron remain solidly profitable last year.

Exxon Mobil still earned a $16 billion net profit in 2015, even though its upstream earnings fell from $20 billion to $7 billion, year over year. Its downstream unit posted a $6.6 billion profit last year, almost double the profit earned in the previous year. Similarly, Chevron earned $4.6 billion in 2015, thanks largely to its refining unit, where profit rose 75 percent, year over year.

Going forward, both Exxon Mobil and Chevron can continue to reign in capital expenditures, which will free up additional cash flow to keep their dividends intact. In addition, both companies have curtailed stock buybacks. All of these measures are taken with the stated goal of preserving their dividends, and thanks to their significant financial flexibility, it is likely both Exxon Mobil and Chevron will continue to pay their high dividends, even at $30 oil.

Companies to watch

Royal Dutch Shell (NYSE: RDS.B): As an integrated major, Royal Dutch Shell has been greatly helped by its refining operation. Refining profits surged 55 percent last year to $9.7 billion. But its upstream profits fell 89 percent for the year.

Based on its Feb. 29 closing price, Shell has a dividend yield above 8 percent. This is more than double Exxon Mobil’s yield, which means investors do not feel confident that Shell can maintain its dividend. Shell pays a $3.76 per ADR dividend, but the company only earned $1.69 per ADR in core earnings. This is a clear signal that the dividend is in danger.

BP (NYSE: BP): Like Shell, BP is a European integrated major with a dividend yield exceeding 8 percent. It is apparent that refining is by far the biggest reason why BP has not cut its dividend yet. BP earned $7.5 billion in downstream profits last year, which was a record for the company. This at least helped offset its upstream losses.

In addition, BP was one of the first, and most aggressive, in the area of divestments. For example, BP sold $10 billion of assets during 2014 and 2015. Since 2010 it has divested $75 billion of assets. Such significant divestitures came at an opportune time, as it helped BP slim down just as oil prices collapsed. However, BP does not have as much opportunity going forward to continue divesting assets. BP lost $6.5 billion for the full year, and if these losses persist, it may have no choice but to cut its dividend.

Disclosure: The author is long BP, KMI

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance. 

Originally published on March 7, 2016