The worst may be over for oil stocks, but does that make Exxon Mobil (NYSE:XOM) a buy? Not so fast! Granted, as energy prices move higher, the company’s prospects look stronger. As InvestorPlace’s Larry Ramer discussed May 13, favorable oil supply and demand trends could boost shares over the next year. Ramer also discussed the company’s high dividend yield. But it’s this strong point that could be a key issue with Exxon Mobil stock going forward.
Why? The company’s current payout ratio is 130.6%. In other words, its paying out more in dividends than it makes in net income.
The recent dividend freeze means these payouts won’t be increasing this year. Yet, paying out more than it earns in the short-term could still affect the company in the long-term. By borrowing money to sustain its dividend, they are eroding shareholder value to save face.
Granted, this venerable oil giant can afford to be generous to income investors. By reducing capital spending, they’ve freed up a bit of cash flow. Also, recent debt offerings have shored up their cash position. You can argue that the company is robbing Peter to pay Paul. Or, more accurately, robbing Paul to pay Paul.
How so? The recent actions to maintain its dividend benefit shareholders in the short run. Investors buying today get a high-yielding stock. But in terms of the stock price going higher, expect shares to disappoint relative to peers.
Let’s dive in, and see why it may be wise to avoid Exxon Mobil stock for now.
Long Road to Oil Price Rebound
Further upside in Exxon Mobil stock hinges on a continued oil price recovery. As oil holds steady around $26 per barrel, it remains to be seen whether oil prices can fully recover to prior levels (above $50 per barrel) within a years’ time.
OPEC sees oil rising to $40 a barrel in the second half of the year. The U.S. Energy Information Administration (EIA) sees oil heading to around $43 per barrel in 2021. But, is this enough to bring Exxon back to profitability?
However, that doesn’t mean that Exxon Mobil stock can’t head higher in the next year. If oil prices head back to $40 per barrel, shares should see a boost.
But that’s not the whole story with the oil giant. The larger issue at hand is the dividend. Exxon’s recent move to mortgage its future to secure the dividend is a reasonable concern.
Dividend Payouts and Exxon Mobil Stock
Why did Exxon maintain its dividend, in light of negative cash flow? Chalk it up to saving face. The company’s reputation as a venerable blue chip was on the line. Cutting the dividend would have been disastrous for the company.
Imagine if they had done so. You’d see score of articles in financial media declaring the “end of Exxon.” Politicians critical of big oil would have a field day retweeting the headlines. Income investors would dump the stock en masse. The remaining shareholders would be pushing for a management change.
Therefore, freezing the dividend was the “least bad” option for the company’s management, but meeting investors half-way still has consequences. Without a dividend increase in 2020, by next year this stock ceases to be a “dividend aristocrat.” That’s not even the worst outcome from this recent move.
As this Seeking Alpha contributor recently discussed, keeping the dividend doesn’t increase shareholder value. But aren’t investors getting a return via the dividend? Yes. Borrowing money against the company’s assets means the overall equity in the business decreases. In turn, this means shares may not appreciate as much if oil prices bounce back.
You may see this as a “bird in one hand is worth two in the bush” kind of situation. Yet, long-term, you may be better off with oil stocks offering a modest dividend, but high potential share price appreciation, rather than a high yield, but lukewarm returns.
Consider Other Oil Stock, But Avoid Exxon Mobil
Granted, the same could happen here with Exxon Mobil stock. But with the company borrowing to sustain its dividend, don’t expect shares to move as highly if oil market conditions improve. Considering this key issue, avoid shares for now, and look elsewhere.
Thomas Niel, contributor to InvestorPlace, has written single-stock analysis since 2016. As of this writing, Thomas Niel did not have a position in any of the aforementioned securities.