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Big Oil Dividends Are A Big Buy

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Big Oil Dividends Are A Big Buy

Aaron Levitt Aug 03, 2016


There are plenty of reasons why investors are drawn to the largest energy stocks out there. After all, companies like Exxon Mobil (XOM ) and BP (BP ) feature plenty of assets, spanning production, midstream and refining sectors. Those assets allow the biggest energy stocks to reap profits larger than the GDPs of some countries.

They also power the major energy stocks big-time dividends.

Or at least they did – until the oil bust. When prices crashed, so did much of the safety of their cash flows. Analysts began to question something previously unthinkable: what if big oil has big cuts coming? While some stocks in the sector did take their lumps and cut payouts, many did not. And that continued to make investors nervous.


But it looks like that was the right decision. Recent rebounds in oil, as well as a few other moves, have only strengthened big oil’s payout potential. For many of the stocks in the sector, their dividends are once again as good as gold.


Oil Sinks Hard


No one anticipated Saudi Arabia to keep on pumping crude oil. That surprise move managed to upend the entire oil market over the last two years or so. It created a huge glut of crude oil that sent prices down to lows not seen in about a decade.

At first, it seemed that many oil companies could handle the price drop, but when prices sank to below $30 per barrel at the beginning of 2015, that was the death knell. The vast majority of wells in existence today aren’t profitable at that per barrel price. As a result, cash flows at the bulk of energy stocks dried up. Many smaller firms with big debts were forced to file for bankruptcy. Medium-sized firms, like ConocoPhillips (COP ), took the painful step and cut their once-lucrative dividends hard. Big oil was unique in that it kept payouts humming along.

However, that wasn’t without consequence.

In order to do that, cash balances were spent in excess, while many launched new debt/bond offerings with the sole purpose of using those proceeds to reward shareholders with dividends. Needless to say, the vast bulk of the analyst community weren’t too pleased. Questions about how long the big oil stocks could keep this up were being asked. Especially when stocks like Chevron (CVX ) now featured payout ratios in excess of 100%.


A Big Turnaround


But in the span of one quarter, things seemed to get better for big oil. With many of the smallest frackers shutting down production or going the way of the dodo, the glut of crude began to ease – and now that glut isn’t so “glutty.” Since bottoming in February, oil has rebounded to over $50 per barrel. It even managed to crest $60 for a brief time before the so-called Brexit. Even natural gas has moved up in recent months.

What that has done is rekindle the profit and cash flow power of the major oil stocks. XOM is simply making that much more today than it was just three months ago. That’s great news for its dividend.

More great news includes other moves during the down turn. For many of the big energy stocks, CAPEX spending has dropped significantly. Aside from just choosing to spend less, many of the biggest energy stocks have been able to reduce costs per well. By “putting the screws” to many of the struggling oil service firms, the major energy producers have improved their margins. With oil rising, that’s big news and only increases their profits and dividend coverage ratios even further.


Big Oil’s Dividends Are Safe and a Big Buy


A rising oil price and lower costs equal safe dividends. It’s as simple as that. As oil continues to rise, or even stabilizes at these levels, investors can rest assured that the biggest energy stocks’ yields – in the 3 to 6% range aren’t going anywhere – barring a full collapse of oil.

And yet, according to analysts at Evercore, the integrated majors are trading at 25-year lows when looking at a variety of valuation and fundamental metrics. Investors can score a big and safe 5% average dividend for dirt cheap. That could make firms like XOM, BP, Total (TOT ), ENI (E ) and the rest of the biggest energy giants big buys.

While they aren’t as exciting as some of the smaller fracking firms in terms of the oil rebound, the major stocks do offer some of the best risk-adjusted returns out there. And a lot of the return will be driven by their once-again safe dividends.

For income seeking investors, this is a great chance to add real yield to a portfolio without going too far on the risk spectrum. The risk is mostly gone at this point, but the yields are still there.


The Bottom Line


Big oil’s dividends are strong today – thanks to rising oil prices and recent cost-cutting moves.

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