In the energy sector, it seems that every major company except for ExxonMobil (NYSE:XOM) is at risk of cutting their dividends. The 'will-they-won't-they' debate rages on, and entirely reasonable for investors to want to know which one could be next. After all, dividend cuts (which by themselves are painful) are often followed by steep drops in share price.
The latest member of Big Oil to cut their dividend, after all-but-promising that they would not, is ConocoPhillips (NYSE:COP). Once again, management-speak was outweighed by the fundamentals. I didn't put much weight in ConocoPhillips' insistence last year that it would maintain its dividend, because the weakness of its business model said otherwise. I wrote two articles in the past quarter about why I expected ConocoPhillips to cut its dividend, despite management's assurances that they would not:
- December 29: Why ConocoPhillips' Dividend May Not Survive 2016
- January 21: Which Is The Better 8% Oil Dividend Stock-ConocoPhillips or BP?
Indeed, ConocoPhillips cut its dividend today by 66%. This article will run down what separated ConocoPhillips from other Big Oil stocks with their own dangerously high dividends, such as BP (NYSE:BP).
What a Difference Refining Makes
By far, the biggest reason why ExxonMobil, and even BP, have kept their dividends intact is because they are integrated, meaning they have downstream businesses in addition to their large upstream operations. ConocoPhillips does not--it spun off its downstream refining business, which now trades independently as Phillips 66 (NYSE:PSX). When oil was at $100 per barrel, this probably seemed like a great way to create shareholder value by splitting up the company. But in hindsight, the decision was a disaster.
The reason is because exploration and production, and refining, tend to move in opposite directions. When oil prices are high, upstream does really well, but refining lags. The opposite is also true, and at $30 oil, integrated majors are skating by thanks in large part to refining, because refining actually does better in an environment of declining oil prices. The reason is because, as oil falls, so do refining feedstock costs. This expands refiners' spreads and profit margins. That's why Phillips 66 stock is up 8% in the past year.
To me, refining is by far the biggest reason why BP hasn't cut its dividend yet. BP earned $7.5 billion in downstream profits last year, which was a record for the company. This at least helped to offset its upstream losses. But ConocoPhillips doesn't have that cushion to lean on now that oil has crashed. It lost $3.5 billion in the fourth quarter alone. That amounted to a loss of $2.78 per share for the quarter. Analysts expected a loss of just $0.65 per share. ConocoPhillips lost $3.58 per share for the full year 2015, while BP's loss was a more modest $1.69 per share.
But downstream isn't the only reason why BP has so far maintained its dividend. BP was more aggressive than ConocoPhillips in cutting spending and selling off assets to raise cash. BP has been in a multi-year downsizing, borne out of necessity after the 2010 Gulf of Mexico oil spill. BP has been in divestment mode since then, which slimmed the company down at just the right time. BP sold $10 billion of assets during 2014-2015. Since 2010 it has divested $75 billion of assets.
As the saying goes, sometimes it's better to be lucky than good, and BP transforming itself into a much smaller company than it was just a few years ago has served it well. For its part, ConocoPhillips announced another 16% decline in capital expenditures for 2016, which is a good step in right-sizing its cost structure. But capital spending cuts take time to hit the bottom line. ConocoPhillips has been less active in divestments than BP. BP also earned a $1.3 billion profit from its equity stake in Russian energy company Rosneft (OTC:OCRNL), which gave a slight boost.
Handicapping Odds of a BP Dividend Cut
To be sure, BP is far from out of the woods. It's in a deeply distressed position itself. BP reported fourth-quarter and full-year results on Tuesday, and the stock promptly crashed 8%. Like ConocoPhillips, BP's results were worse than expected. BP's fourth-quarter earnings collapsed 91% year over year. BP lost $6.5 billion for the full year.
BP racked up a massive loss last year too-but it kept its dividend unchanged. Management once again pledged that the dividend is the top priority within the financial framework, but investors should take this with a huge grain of salt, considering ConocoPhillips said the same thing. There remains a decent chance BP can keep its dividend, thanks to its refining success and its massive asset sales. As a result, I'd say odds are 50-50 that BP will cut its dividend this year, absent a notable rally in commodity prices.
Disclaimer: This article represents the opinion of the author, who is not a licensed financial advisor. This article is intended for informational and educational purposes only, and should not be construed as investment advice to any particular individual. Readers should perform their own due diligence before making any investment decisions.
Disclosure: I am/we are long BP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.