Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
Oil majors like ExxonMobil and Chevron have been seen as relative bastions of safety in the tumultuous oil market. I'm here with Josh Peters, editor of Morningstar DividendInvestor, for his take on their dividend-paying potential.
Josh, thanks for joining me.
Josh Peters: Good to be here, Jeremy.
Glaser: ExxonMobil and Chevron recently held analyst days. When you look at their positioning in the market right now, do you still think they are going to be able to withstand the turmoil we've seen in energy?
Peters: A lot of it, unfortunately, comes right down to the oil price, and if oil is below US$40, even Exxon may run a deficit after it's paid its dividends. It's not going to generate enough free cash flow in order to fully fund that dividend.
Now over a shorter period of time, a couple of years, if oil prices don't recover, what you have with Exxon and with Chevron--I own and have owned Chevron for a number of years; I haven't owned Exxon before--they have the balance sheet capacity to finish their big capital projects. Capex (capital expenditure) is going to fall; that's going to help cash flow. They have the ability to cut costs. They can do a lot of things at once. That's the advantage of having these very strong balance sheets in a cyclical industry going into the down part of the cycle.
But at the end of the day, the most important margin of safety for these stocks is excess coverage for the dividend, either on a free cash flow basis or an earnings basis--I frankly would prefer both. At this point, both companies need a rebound in the oil price, in addition to all of the cost-cutting that they've put on the table in order to make these existing dividend policies work over the long run.
That's not the greatest position to be in from the standpoint of a dividend investor. I'd still rather be with these two names--one or the other (again, I own Chevron)--than with ConocoPhillips, which has already cut its dividend, or BP or Shell. These are dividends that look very vulnerable to me.
Glaser: You mentioned cost-cutting. Do you think that spending less on capex is going to result in slower growth in the future? Is it going to restrain dividend growth?
Peters: That's going to depend. Part of the cost-cutting that goes on in these businesses is automatic. For instance, oil prices come down, you pay less in royalties and taxes. So some of it is indexed directly to the commodity price.
On the capital side, for a while it was drill, drill, drill. Everybody in the world was trying to expand production as fast as they could to meet demand in that US$100-plus oil environment. And that meant service providers could run up their prices, because there was more demand than supply of oil services and drilling services. Now that budgets are being cut everywhere, you also have the opportunity for those who are still maintaining some drilling activities to take advantage of lower prices. So, that's an advantage.
But there are only so many projects, even for an Exxon and a Chevron, that are really economically viable at these low oil prices. If they're not spending because they don't have the opportunity, they don't have the cash flow in order to do it, and they don't have projects that are providing a good return on and of capital at, say, US$30 oil or US$35 oil, then that's definitely going to take a toll on their ability to grow.
That really gets to the heart of some of my concerns here. Even if the dividends are safe--and I think Exxon's in particular are very unlikely to be cut; there is a little bit more risk at Chevron, but I think they've got the capacity to see through another couple of years of low oil prices before they'd have to really consider the dividend rate. So it's more about, what's the growth component? That's what I am pondering.
Glaser: If you think it's safe, but maybe won't grow, and there are other risks out there, should dividend investors consider these oil majors, or are there other parts of the market that may be more attractive.
Peters: You have to start, like I always do, from the standpoint of what am I trying to achieve with my portfolio as a whole. For a lot of years I've owned these … well, I used to own Shell, still own Chevron--again, for sixth time: I own Chevron. I felt like there was some value and hedge, that almost all of us, unless we're off the grid in a cave in Montana someplace, are consumers of energy, consumers of petrochemical products. Why not have some hedge against a supply shock or a future of very high oil prices? These stocks could essentially punch a little bit above their weight, contribute more to the portfolio from a risk-management standpoint, than just in terms of dividend yield plus dividend growth.
I am not really persuaded of that value at this point. Just because we've seen how commodity-price dependent the total returns these stocks can offer is. So at this point, I look at Exxon with a mid-3% yield and Chevron with a high 4%, maybe 5% yield depending on the day--we've had a lot of volatility. I still need a lot of dividend growth from each of these companies over the long run to really feel like I'm being compensated for the risk that I'm taking. If you want to make a directional bet on oil prices, there are better ways to do that. You could buy oil futures. You could buy an oil ETF. You could buy smaller, higher-cost, highly levered E&P companies that would give you the maximum bang for the buck in an upside oil price scenario.
I'm questioning: Other than just a reliable dividend that has a big yield right now, am I getting enough from these oil majors to really make them work for my strategy? I'm still thinking about it, but I have come at least this far that I don't really consider Chevron a core holding anymore. I think that you could have a portfolio of dividend-paying stocks that could serve your real-world needs quite well without having to have this energy exposure. It's the same approach I have with technology; I don't own any tech stocks. I don't think a dividend-oriented investor needs tech stocks in their portfolio. You might need utilities, you might need REITs, you might need some staples, but it's basically a matter of risk/reward, and if these stocks aren't moving you closer to your objectives, you don't really need them for any other reason.
Glaser: You don't need to see the fall in oil prices as necessarily an opportunity.
Peters: No, I am not looking at it as an opportunity. I am looking at it more as an opportunity to deepen my thinking about risk-management for my strategy. This risk of an oil-price collapse was always there. The margins of safety, so far, have proved sufficient. But if it's "lower for longer," in oil, then these are stocks I may yet regret owning, and I never like to be in that position.
Of all the stocks I own right now, including a couple of midstream names, Chevron--even after the analyst day, which I thought was fairly positive--is still the one I am most concerned about in terms of the threat to the dividend: a dividend cut, as well as the lingering challenge of perhaps really poor dividend growth over an extended time horizon.
I don't have an answer for you yet, but these are decisions [that help] frame the question, [which is] very important for every investor to do if they are interested.
Glaser: Josh, thanks for the update.
Peters: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
