A great Italian philosopher once said it’s hard to make predictions, especially about the future.
There was nothing wrong with the premise. Shares in companies across the energy sector are getting crushed by the rout in oil prices. Any time a stock gets clobbered, it deserves a closer look — that’s how you find bargains. The idea is to buy low, remember?
With bargain hunting as the goal, we searched for a large-cap oil stock with a big balance sheet and fat, reliable dividend that looked like it was on sale. Sure, investors would have to be patient until the oil market turned, but at least they’d get a generous income stream while they waited for upside.
After sifting through the sector’s heftier names, I landed on COP stock as a slam-dunk buy. It appeared to check all the boxes an investor could want for a long-term value stock.
Wow, I was way off.
Just days after I made my table-thumping bull case for COP stock, the world’s largest independent exploration and production company did the unthinkable.
It cut its dividend.
COP Drops the Big One
In my defense, no one saw this coming. Analysts and investors were shocked and stunned. Research shops were telling their clients that maintaining the dividend was COP’s top priority.
The market couldn’t believe it, either. COP has stock lost 16% since it said it would slash its payout.
Almost no one was pricing this in. As of Jan. 26, 3.3% of COP stock’s float was sold short. That’s not nothing, but in no way does it suggest that investors were expecting something ugly.
You just don’t touch the third rail of investing, especially when the balance sheet and cash flow statement aren’t on fire.
COP generated cash from operations of $7.6 billion last year and ended 2015 with $2.6 billion in cash on hand. Furthermore, the company had $8 billion of liquidity at the end of the year with no significant near-term debt coming due.
There’s nothing wrong with wanting a bigger financial cushion, but COP could have afforded to disburse $3.7 billion in dividends as it did last year. The balance sheet had a slow leak. It wasn’t about to founder.
Besides, dividend payers bend over backward to protect their payouts. They cut operating costs or go with a full-on restructuring, sell assets, slash share repurchase programs, sell debt, look under the couch cushions or have a bake sale.
Even more incredibly, COP’s dividend was best thing about the stock. As angry analysts and investors were quick to point out to management, the outsized dividend was the big thing that made COP attractive versus its peers. It was the only thing that made it special.
Lastly, it was reliable. Hell, COP hadn’t cut its dividend for 23 consecutive years.
But cut it, it did. The COP dividend is now 25 cents a share, down from a prior payout of 74 cents a share. In other cash-saving moves, COP reduced 2016 capital expenditures by another $1.3 billion and operating expenses by an additional $700 million.
The company said the cuts represent an incremental $4.4 billion in potential cash-flow improvements versus prior guidance. COP is hunkering down for a long slump in oil prices, and I can’t fault management for being prudent.
The whole episode underscores — for me, at least — how dangerous energy stocks really are these days. I truly underestimated the risks.
Ordinarily, any time a dividend yield gets as high as what COP was throwing off (more than 8%!), there’s a very good chance that it’s a land mine. And yet I talked myself into thinking it was safe.
Dividend anxiety is on the mind of every shareholder in the energy sector for a good reason. I should have taken that dread much more seriously.
I screwed up. It happens. I’m sorry.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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