The big oil companies—at least in this oil price environment—have come under a lot of criticism for their decision to generate cash flow rather than focus on return on equity. Much has been discussed about the dividend-paying capabilities of the companies, as that they have dished out dividends that have often exceeded their earnings.
Is this a sound strategy, and should investors continue to hold onto the big four stocks?
The big four oil company’s dividend payout in 2015 was more than 100 percent of their profits. The situation got worse in 2016, when Exxon ponied up a whopping $3.1 billion in dividends for Q2, against a net income of $1.7 billion, according to S&P Global Market Intelligence. The gap was likely filled by taking on debt.
The net debt of the big four oil companies; Exxon Mobil Corp., Royal Dutch Shell PLC, BP PLC, and Chevron Corp, has more than doubled in the last two years.
The debt to equity ratio of Exxon is the least at 18 percent, while Shell has the highest gearing of 28 percent, likely to reach 30 percent, according to their Chief Financial Officer Simon Henry. BP is also expected to have a gearing of 30 percent by end 2017, according to Jefferies analyst. For the sake of comparison, in 2012, Exxon’s debt to equity was just 1.2 percent, and Shell’s was only 10 percent; looking back to a decade ago, Exxon had no debt at all.
One could assume that this means that as and when the oil prices rise, the oil companies will be in a condition to once again generate enough profits to pay off the debt, massive as it may be.
Though the companies are resorting to asset sales, job cuts, and other budget cuts to survive the downturn, many have asked why they continue to dish out dividends to their investors.
Globally, more than $9 trillion of government securities yield below zero, according to Bloomberg Barclays index data. In such an environment where investors are scrounging for yields, the big four oil companies offer mouth-watering ones. Exxon has a dividend yield of 3.4 percent, Chevron has a yield of 4.19 percent, BP has a yield of 6.68 percent, and Royal Dutch Shell has a dividend yield of 6.4 percent.
This has led the investors to continue holding the stocks of these companies even during such a massive oil rout. If the investors bail and trigger a sell off of these stocks, it would dampen the sentiment towards their stock, and the companies would find it difficult to raise new debt. Hence, taking some debt to continue paying dividends is the smart strategy—and possibly the only strategy—to follow.
“They’re so big, they can diversify, they have more levers to push and pull in terms of shoring up their creditworthiness,” said Wilmer Stith, senior fixed-income portfolio manager at Wilmington Trust, which has $73 billion in assets under management, reports The Wall Street Journal.
The U.S. Energy Information Administration has forecast WTI to average $51 a barrel in 2017, which supports the approach followed by the oil companies.
If crude averages between $50 to $55 a barrel, BP believes that they will not only be able to pay dividends, they can even invest in new operations to search for more oil.
The recent rebound in crude prices is good news for the oil companies.
“Over the last year, integrated oil and gas companies have accelerated reductions in their operating costs to adjust to earlier oil price declines. As a result, most companies’ upstream operations returned to positive net income generation in the second quarter of 2016, while also benefiting from an uptick in the price of crude,” says Elena Nadtotchi, a Moody’s Vice President — Senior Credit Officer and author of the report, reports Hellenic Shipping News.
Considering the cyclical nature of oil, the approach of the oil companies is correct, but if oil should take a lot longer to recover, then the oil companies may have to rethink their strategy.
By Rakesh Upadhyay for Oilprice.com
More Top Reads From Oilprice.com:
- Could The Bottom Fall Out Of This Oil Rally?
- The Resurrection Of Putin: What It Means For The Oil Markets
- 2016 Oil Price Forecasts: Why Is Everyone Getting It Wrong