The US stock market has been weak this month as evidenced by the S&P 500 (SPY) falling almost 4 percent. The two main fears seem to be interest rates accelerating upward, combined with the Federal Reserve hinting it may begin tapering its asset purchases as early as September. It is at exact times like this where the long term, patient investor can outfox the big boys and acquire shares in well run companies at a discount. I believe we are witnessing that exact scenario unfolding in the oil industry. To say the least, sentiment on the industry is very negative at this moment as funds come flooding out of these names. The article below will discuss my two favorite plays in the sector. Both of these companies are conservatively run and pay a consistent rising dividend making them well suited for dividend growth investors as well.
My favorite company in the sector is Exxon Mobil (XOM). XOM is the largest publicly traded, fully integrated energy company in the world. It has extensive operations throughout the world with production almost evenly split between natural gas and oil. XOM currently pays out a quarterly dividend of 63 cents a share for a current yield of roughly 2.9% at the time this article was written. The dividend is an important part of the overall return that shareholders can expect from owning these securities. XOM has managed to raise its dividend in the last 10 years from roughly 98 cents a share to its current $2.52 cents for a compounded annual growth rate of 9.9%. The dividend growth rate comfortably outpaces inflation providing a rising annual income stream that is invaluable especially to retired investors.
The second way that XOM rewards shareholders is with its consistent buyback policy. The share count in 2003 was 6.568 billion, with the number shrinking to 4.5 billion by the end of 2012. This works out to a compounded annual buyback of roughly 3.58% a year. I realize that the buyback policy of XOM is unpopular with many retirees who would much rather have higher dividend payouts. I prefer the buybacks for two reasons. The primary reason is as a long-term shareholder my share of the company's future income stream rises with fewer shares available. I have at least 20 years to go before retirement so I can afford to take the long view. The second reason revolves around the multiple afforded by the company. XOM is trading at a multiple that is far less than the market average making a buyback program the correct action to take in this environment. Management needs to repurchase shares when they are on sale, not when they are expensive.
The second company that I would like to highlight is Chevron (CVX), which happens to be the world's fourth largest energy company. CVX's current production is roughly 65% oil, with the rest coming in the form of natural gas. CVX currently pays out a quarterly dividend rate of $1 per share for an annual yield of roughly 3.38%. CVX has an excellent track record of raising its dividend as well. The compounded annual growth rate of CVX's dividend is 10.55%, which again comfortably outpaces the rate of inflation.
CVX has also managed to buy back its shares but not at the same pace as XOM. The compounded annual rate of CVX's buyback works out to roughly 0.95%. CVX has outperformed XOM over the last 3 and 5-year time frame. The outperformance in my opinion is due to XOM's XTO energy acquisition and the corresponding change in its production. Natural gas now accounts for 50% of XOM's production in a time where natural gas prices have been weak.
Being an energy company requires constant replenishing of depleted assets. CVX's current 5-year replacement rate is 94% versus an industry average of 107%. I don't view this as a problem at this time. CVX has numerous large deep sea drilling activities that should allow the company to close the gap in a hurry, once fully operational. XOM rate is a bit better with a ten-year average of 121%. 2012 replenishment numbers were over 100% indicating that XOM's capital projects are bearing fruit. I have no doubt both CVX and XOM will be able to maintain their production and exploration ability well into the future.
Both of the above mentioned companies are commodity producers so a discussion of the underlying trend of their end products is warranted. The price of West Texas Intermediate crude oil is up year over year and trending higher. Surprisingly, the price of oil now is significantly higher than what was witnessed in May. Natural gas prices are up as well when compared to the same time last year. The earnings stream of both XOM and CVX are highly correlated to the price of oil and gas. A corresponding collapse in the price of energy such as what was seen in the worldwide recession of 2009 would adversely impact both companies' earnings.
I find it to be a useless endeavor trying to pick a recession. I prefer to focus on the company's long-term potential. Both XOM and CVX have an enviable track record of generously raising dividends on a yearly basis. In my view, this makes them excellent candidates for income seeking investors. What really makes them stand out in my view is the CAGR of their dividend. Very few companies are able to sustain and continuously raise their payout in the manner that XOM and CVX have. In my opinion, at least one should be included in a dividend growth investor's portfolio.
In summary, the large energy companies highlighted above are deeply out of favor and have sold of briskly since the end of July. The sell-off in my opinion is an excellent opportunity for a long-term patient investor to acquire them. The dividend flow that will emanate from these companies will go a long way to augmenting/replacing income in retirement. Thank you for reading and I look forward to your comments.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.