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At this point, it’s no secret that the energy sector is hurting pretty badly right now. As prices for crude oil and natural gas have fallen to lows not seen in decades, profits at most energy firms are basically nonexistent. In fact, most energy firms are losing money hand over fist.
Case in point: sector stalwart and former dividend champion ConocoPhillips (COP ).
I italicized the word former for a reason. Under the weight of falling commodity prices, COP did the unthinkable in the world of dividend investing: it slashed its payout. Hard. That alone was enough to send shares of the stock down around 9% on the news. For those investors already holding COP, the dividend cut is just extra salt poured onto the wound of a 46% decline in Conoco’s share price over the last year.
However, for those investors taking a fresh look at COP, the decline in shares is tantalizing, as is the firm’s newly minted 3% dividend yield. The real question is whether or not it’s enough of a bargain to pull the trigger.
Conoco hasn’t exactly been rolling in the dough the last few quarters. Since spinning out its refining operations as Phillips 66 (PSX ), COP has been 100% focused on drilling and producing energy. There’s no downstream sector to feast on lower crude oil prices which help reduce upstream losses. And when your profits are 100% derived from the underlying cost of crude oil and natural gas, every dip really hurts your bottom line.
When the dips are actually huge depressions, things get nasty.
As such, this was the quarter that finally broke COP’s back. Conoco managed to lose a whopping 90 cents per share. That works out to a $1.1 billion loss on the quarter, way worse than analysts had predicted. At the same time, despite rising production, Conoco saw lower revenues as well. What’s more is the firm’s full year earnings were pretty darn terrible as well.
With a $7.2 billion operating loss for the full year under its belt, Conoco did what many corporations absolutely hate doing. The company cut its dividend, slashing its payout from 74 cents per quarter down to just 25 cents.
The cut is especially painful for long-term investors or for those who used COP as a dividend growth investment. Conoco has paid a steadily rising dividend since 1995.
After all is said and done, COP is now sporting a 2.9% dividend yield. That’s still pretty high for an energy sector stock. So the question is, is that yield worth buying today? The answer could be a resounding yes.
To start with, while painful, the dividend cut does free up a lot of cash at Conoco. Management estimates that the cut will save COP around $4.4 billion in potential cash flow improvements. That goes a long way in removing some of the issues at the energy firm. One of the major criticisms with COP was that despite generating cash flows from operations of approximately $7.6 billion last year, it was overspending. In order to keep the wells pumping, COP took out some debt. That’s okay in the short run, but with oil staying down longer it’s not a great multiyear plan.
The dividend cut eliminates the need to tap the debt markets in such a huge way and boosts the firm’s balance sheet.
And when it does need to tap the debt markets, it can do so in a cheaper way. During the firm’s recent conference call discussing the dividend cut and earnings, the company mentioned that ratings agency Moody’s was on the prowl to deliver “multinotch cuts” to several of the larger E&Ps. Investment bank Credit Suisse echoed the sentiment in Barron’s. By getting out ahead of this, COP may have prevented a major downgrade to its rating.
Additionally, other moves will help set the stage for a more sustainable dividend payout in this environment. For example, CAPEX cuts and asset sales will help reduce the firm’s breakeven point for production down to just $45 per barrel. All in all, the dividend cut makes COP a “safer” dividend play going forward in the new energy environment.
And let’s not forget that as the world’s largest E&P firm, COP still has plenty of long-lived, low-decline energy assets. From new oil sands projects and LNG exporting terminals to huge legacy assets in Alaska, Conoco has the goods. With the lower breakeven point, those assets are even better in an oil price recovery environment.
With the recent dividend cut and its other cost-cutting moves, COP is now more than able to make it to the point when oil prices recover in a more healthy fashion. That’s really good news for investors, especially those buying its 2.9% dividend yield today.