At the beginning of 2011, ConocoPhillips (NYSE:COP) paid out a quarterly dividend of $0.66 per share. On March 1st, 2013, Conoco paid out a quarterly dividend in the amount of $0.66 per share. Usually, the energy giant declares its second quarter dividend sometime between the first and second week of May, so a dividend announcement from the company is likely forthcoming.
Although the company effectively raised its dividend in 2012 by spinning off Phillips 66 (NYSE:PSX) which paid out its own dividends to shareholders, the fact is that Conoco has been paying out $0.66 dividends for nine straight quarters. As of its latest issue, Value Line began predicting that the total annual payout for shareholders will remain at the $2.64 annual mark for the rest of the year.
Personally, I have no special insight as to whether Conoco will raise its dividend this year. They could raise it next week, they could raise it in the third quarter or fourth quarter, or they could keep it steady at $0.66 per share. In that regard, I do not know anything you don't. Rather, as a shareholder, I want to share my thought process about how I plan to respond in the event that the company does not raise its dividend this year.
First of all, I should acknowledge that some dividend investors automatically sell a stock once it stops raising its dividend annually. This is an intelligent approach, because there are plenty of companies in corporate America that do raise their dividends every year, and if your objective is income growth, it would make sense to own companies that meet that objective in line with your expectations.
With that said, I do not automatically sell when a company freezes (or, if the situation is particularly extreme, cuts) its dividend. I treat dividend stagnations or declines as periods of reassessment.
In the case of Conoco, dividend freezes have been a regular part of its corporate history. Conoco paid out the same amount in 1993 and 1994, and paid out the same amount in 1998, 1999, and 2000 (and the annual raise was only $0.01 from 1997). A dividend freeze would not exactly be an unprecedented event in Conoco's corporate history. If you want guaranteed dividend raises each year, Exxon (NYSE:XOM) and Chevron (NYSE:CVX) are probably your best bets in the industry.
When I make an investment in a cyclical industry that involves commodities, I do not proceed with the same expectations that I have for Coca-Cola (NYSE:KO), Johnson & Johnson (NYSE:JNJ), and Colgate-Palmolive (NYSE:CL). I expect those companies to increase their dividends every year without exception. But in the case of commodities, I tend to think in terms of rolling five-to-ten year periods (rough approximations of the business cycle). A company like Royal Dutch Shell (NYSE:RDS.B) has returned 14% annually since the 1920s if you trace it back to its earliest corporate forms, and over 70% of those returns can be attributed to the company's traditionally high dividend payouts, but they have fluctuated along with the boom and bust cycles in the energy industry (some investors are more well-suited for tolerating this fact than others).
In other words, with a company like Conoco, I want my dividend to be much higher in 2018 than it is now, and much higher in 2023 than it is in 2018. I recognize that I'm not going to get smooth 7-11% annual increases like you get with Procter & Gamble (NYSE:PG). I reach that conclusion with Conoco in particular by taking into account its history and recognizing the volatile nature of commodities investing.
When analyzing a potential dividend freeze, the most important thing for me to evaluate is this: Has the long-term earnings power of the company been compromised?
In the case of Conoco, I believe the answer is no. Right now, the company is in a transition process as it continues to divest non-core assets and make heavy capital expenditures in higher margin areas. The consequence of this is that production levels get immediately affected by Conoco's asset sales while investors have to wait for the new projects to materialize.
I'll give an example to illustrate the point. Part of Conoco's $12 billion worth of divestments in the past year have included the sale of the Cedar Creek Anticline properties to Denbury Resources. That property had been producing 13,000 barrels of oil equivalents per day. Obviously, the impact is somewhat immediate: these kinds of divestments will no longer be producing earnings and dividends for Conoco shareholders.
Meanwhile, the company is taking its cash proceeds from its divestments (and part of its cash flows from operations) to make investments in areas that the company believes will yield higher margins on operations. Think Bakken formation. Think Permian. Think Eagle Ford. The problem is, many of these investments are not going to have an immediate impact on earnings. The analyst estimates call for Conoco to increase its production from 1.5 million barrels of oil equivalents per day in 2013 up to 1.8 million barrels of oil equivalents per day in 2016. The important thing for Conoco shareholders to recognize is that the company will be generating higher margins on its operations when it increases future output. The difficult part for shareholders, though, is that the divestments hit the balance sheet much quicker than the new investments which do not materially aid the bottom line until 2015/2016.
While I'd like to see a dividend hike, I can tolerate a static dividend because the long-term earnings power of the company remains sound. Assuming oil prices do not fall more than 15% over the next five years, the company should be generating about $6.50-$7.00 per share in 2017/2018 when the new projects begin to aid the bottom line. Conoco seems to be in a transition phase to grow stronger. Don't forget, this is a company with almost 9 billion barrels of oil and oil equivalents in proven reserves. If the dividend remains frozen for a little while, I'll be sitting tight.