Lately, I’ve been reviewing the relationship between dividends and earnings (as well as cash flow) among five of the six energy supermajors on the planet: ExxonMobil, Chevron, BP, Royal Dutch Shell, and ConocoPhillips.
And I was struck by one fact in particular: the dividends at all five companies consumed less than 40% of the cash flow per share (note: I normalized the figures at BP to adjust for the asset shedding in response to the potential litigation risk). Considering that Exxon paid out 76.7% of its cash flow as dividends in 1968, this is marked shift in the general strategy of the oil supermajors over the past several decades.
Nowadays, oil companies have a larger buffer to absorb the shock of a steep commodity price decline and still maintain dividend payouts. We kind of see that with Conoco Phillips right now. The company is in the process of transition to a higher margin business, so it has been holding the dividend steady at $0.66 per share and ceasing stock buybacks while it adjusts its assets for the future. If prices actually fell substantially, I would expect the other oil companies to follow that kind of outline: stop the buybacks, lower the capital expenditures, protect the dividend and hold it steady until commodity prices rise again. That’s the general blueprint map that it seems like the big oil companies are following.
As an aside, a lot of people will ask “Should I buy Exxon, Chevron, or BP right now?” Or maybe they will ask about Shell and Conoco. The answer is usually: all of the above. That is because, although management matters, there is little product differentiation among the companies: oil is oil, natural gas is natural gas, and so on. Obviously, the companies have different amounts of each, different debt structures, different locations of assets, and so on, but the underlying product is the same. It is highly unlikely, for instance, that we will live in a world where Exxon is expensive while Chevron is wildly undervalued. The exception, of course, would be if one of the companies experienced a significant one-time event like BP with its oil spill.
If you reach the conclusion that we are living in a time of stable commodity prices, then a stock like Conoco, BP, or Shell would be a great way to get a high starter yield without engaging in the dreaded “reaching for yield” that can plague some income investors. As long as oil prices remain stable or increase, we are living in a time where oil companies are a triple threat of sorts: they pay out a good dividend, they buy back decent-sized blocks of shares, and they make meaningful investments for future growth. Although some companies like IBM and General Electric are currently engaging in similar behavior, the oil industry provides fertile research ground for investors that appreciate the harmony of growing dividends intermingling with a lower share count and investment in future growth.
The bottom-line for oil investing is this: if you want a dividend that goes up every year, no questions asked, Exxon Mobil is your best bet. It has been paying out dividends without interruption since the 1800s, growing them every year for three decades, and thanks to the Exxon and Mobil merger, wields the greatest economic might from a domestic oil company that we have seen since John D. Rockefeller’s Standard Oil got broken up by the trustbusters.
If you want a dividend that has a 90% chance of going up every year, look to Chevron. The appeal of Chevron is that it is almost as strong as Exxon, but because it is a lot smaller, it has more room for growth, and absent an extreme crash in commodities pricing, should raise its dividend every year.
For investors that think exclusively in terms of dividend growth, Exxon and Chevron are the best bets.
However, if you are more tolerant to dividend freezes and cuts during extreme declines in the energy markets, then it might make sense to look at Conoco, Shell, and BP. Each of these companies offer much higher yields than Exxon and Chevron, and over most rolling ten to fifteen year periods, will pay out more in dividends than Exxon and Chevron. The catch is that the dividend growth is not as resilient during an energy bear market.
Some investors like to see a growing dividend in all environments. If that fits your personality, the safety of Exxon and Chevron likely fits your investment profile. If you want decent-sized chunks of income that might go down or freeze two years out of every fifteen or so, then it may be worth exploring the oil supermajors. There is no “right” or “wrong” answer. It’s all about knowing what you want, and what you are willing to tolerate during realistic worst case scenarios. Some people are equipped to adopt the long view and think in terms of full business cycles, and others income investors strategize to create an income stream that grows in all market conditions as the first priority. As the famous Oracle of Delphi said to the ancient seer Tyresias: Know thyself.