Crises in the financial and commodity markets are nothing new. We are little more than seven years removed from the paradigm-shattering collapse of 2008, and fairly recently, gold and silver markets were in perpetual decline until this month.
It stands to reason, then, that oil investors shouldn’t panic — the sector will eventually recover. Yet as the energy markets continue their descent, dividends — one of the key selling points of oil stocks — are under massive pressure.
When national gasoline prices blew skyward at the turn of the century, oil companies understandably drew the ire of the general public. But their profitability potential was undeniable, both in the form of capital gains and through generous dividends.
One clearly fed the other. And when the energy markets first began to tumble in the summer of 2014, oil companies had plenty of cash reserves to service their dividends.
That bonanza is drying out.
As the oil markets unexpectedly fell to fresh multiyear lows, independent oil producers like Marathon Oil Corporation (MRO) and Kinder Morgan Inc. (KMI) were forced to cut into their dividends. Even the sudden collapse in 10-year U.S. Treasury yields despite a hawkish U.S. Federal Reserve isn’t enough to prop up oil stocks.
The bearishly unique fundamentals of global economic weakness, aggressively negative sentiment and a severe oil supply glut will likely put even Big Oil dividends under the gun. The downfall of Chinese stocks isn’t just a “paper loss” — China accounts for about 12% of total oil consumption.
Both the domestic oil index West Texas Intermediate and the international benchmark Brent Crude Oil are rapidly approaching two years of persistent declines. And the earlier proposed production cut by the Organization of Petroleum Exporting Countries has been largely stymied by regional rivalries, though an agreement between Saudi Arabia, Russia, Venezuela and Qatar to freeze production levels was announced today.
While Big Oil companies may feel safe now, no entity is immune from cash flow problems. Here are three major producers that face risk toward their dividends.
Dividends at Risk: Exxon Mobil Corporation (XOM)
There is a massive shakeup in the previously unassailable oil industry, and it will surely reverberate across the entire financial spectrum.
Exxon Mobil Corporation (XOM) is one of only three American companies that currently hold the credit ratings agency Standard and Poor’s top ranking. However, that lofty position may soon face a downgrade, as the terribly bearish oil markets have impacted both the XOM stock price and its ability to pay dividends.
If a credit downgrade were to occur, experts agree that it would likely be a single notch south. Even so, the implication for XOM’s dividends is rather pessimistic. Since the end of 2010, XOM’s cash on hand dropped some 45%. A similar reduction is evident in free cash flow.
What is especially disconcerting to XOM’s accountants is that capital expenditures are taking more away from cash flow from operations than in previous years. All of this contributes to less resources to pay off dividends.
XOM’s dividends payout ratio is also problematic, with rising trends suggestive of non-sustainability. Between 2006 and 2012, the average payout ratio was fairly stable at 24%, save for the notable exception of 2009 when the broad markets were gripped in recessionary pressures. But over the past three years, the payout ratio doubled to 48% and currently sits at about 60%. While there’s no set standard for what is considered a “stable” ratio, the jump tells us that an increasing amount of XOM earnings is being siphoned away by dividends.
Exxon Mobil is the king of Big Oil, so dramatic changes in the immediate term are unlikely. Nevertheless, don’t get fooled into complacency. XOM stock is still subject to oil volatility, and that will inevitably pressure both market value and dividends.
Dividends at Risk: Chevron Corporation (CVX)
What has become clear in recent months is that no one is safe from the sustained crash in the oil markets. Just ask Chevron Corporation (CVX), which suffered an earnings loss for the fourth quarter of fiscal year 2015.
Long-time CVX stockholders had’t seen the oil producer go into the red since 2002.
In a sign of the times, CVX also saw a credit downgrade by S&P to AA- from AA, according to Bloomberg. Despite the shock to Wall Street, Chevron’s management remained resolute, promising to deliver on $2 billion worth of dividends for the quarter.
There’s an obvious question — how long can CVX continue making good on these promises? While its balance sheet can support the dividends, it’s becoming a worrying proposition. On-hand cash is down nearly 22% from five years ago, while long-term debt has jumped 242% over the same time frame.
Liabilities aren’t the end-all, be-all of the story, but free cash flow has been negative since fiscal year 2013. In response, CVX will probably again introduce cost-cutting strategies, but it’s evident that they are steadily losing this battle.
Current CVX stockholders should savor the incoming dividends — moving forward, the situation does not appear stable. Like its chief rival XOM, the dividends payout ratio for CVX was mostly consistent over the past decade. However, in the past two years, we saw a massive spike in the average payout ratio to nearly 109%. Unless the oil markets begin a rapid recovery, CVX management will have to make painful decisions regarding dividends.
If there’s any consolation, it’s that every competitor in the oil industry is facing similar, or even more severe, circumstances. But for the long-term investor who has grown accustomed to generous dividends, a potential cut would be especially painful.
Dividends at Risk: ConocoPhillips (COP)
The writing was on the wall, and ConocoPhillips (COP) made the decision to take it on the chin. COP joins the ranks of other oil explorers who have skimmed their dividends in order to stave off a severe financial crisis.
Truthfully, COP had little in the way of choice. Its Q4 FY2015 earnings result was its worst performance since the 2008 global economic collapse. Falling energy prices — which show little evidence of abating — gutted COP’s prized oil fields.
Sadly, it could get even more desperate before it gets better.
One of the biggest gaps in COP’s financials is the ugly trend in free cash flow, which has been in the red over the past seven consecutive quarters. Without cooperation from the underlying oil markets, this pessimism will not improve unless radical changes are implemented.
Top-line sales fell off a cliff, with FY2015’s result 84% below that of FY2010. COP’s ability to service its debt and other obligations is further questioned by a 74% reduction in cash over the same time period.
Simply put, full dividends were just not an option.
With the drop in payout to 25 cents per share from 74 cents, ConocoPhillips immediately lost its major selling point as the provider of the most generous dividends.
Theoretically, COP now has more resources to pay for costs related to oil exploration and finance charges for its long-term debt. But with further credit downgrades expected for the industry, the dividend cut may still be ineffective. It certainly wouldn’t be out of the question to see COP further reduce its payout if the oil markets remain subdued.
ConocoPhillips’ early investors had an amazing run. But the high dividends in light of an extremely bearish sector eventually became too good to be true.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.