By Rakesh Upadhyay
Are you tempted by nice dividends such as BP's (NYSE:BP) 7.53% and Shell's (NYSE:RDS.A) 7.31%? Long-term investors are. They're lapping up the oil majors on dips to cash in on their impressive dividend yields in hopes that the massive rally in crude oil from the lows of $27.10 per barrel is an indication that crude has bottomed out and higher prices are around the corner.
Large investors are pursuing the oil majors for their stability and safety, which has boosted their prices, but even after the rise, prices remain below their 2015 highs.
The oil majors are expected to report poor numbers this earning season. Jefferies' equity analyst Jason Gammel believes that the "1Q16 reporting period looks set to be even worse than what we thought was already an especially ugly 4Q15."
The U.S. Energy Information Administration (EIA) has forecast an average price of $35/b in 2016 and $41/b in 2017, which is well below the 2015 average of $49/b.
Though the oil companies have cut costs and scrapped investments for the future projects, an average price realization of $41/b by 2017 will test their resolve to continue paying high dividends.
Under such circumstances, is buying the oil majors a smart strategy?
The stock market is forward looking. Analysts and investors always focus on the future prospects while valuing a company. And there are, in fact, a couple of points in favor of the oil majors.
The worst in terms of oil prices is behind us. Oil demand remains robust whereas production is decreasing. The supply glut is likely to ease considerably by the year's end. All of this is positive news for the oil companies.
Consider the dividends of the oil companies, BP at 7.53%, Royal Dutch Shell at 7.31%, and Total S.A. (NYSE:TOT) at 5.65%. In a world of negative interest rates, these are tempting yields for the long-term investor --and if oil prices continue to move higher in the future, the current prices will prove to be a steal.
So what are investors to do?
The answer depends somewhat on your investment objective, but generally speaking, any investor buying into the oil majors for their dividend yield should be ready to face disappointment in the near future.
Italy's ENI S.p.A. (NYSE:E) reduced its dividend by 30% in 2015. Spain's Repsol (OTCQX:REPYF) cut the dividend by 20% for 2015, compared to its pay out in the previous three years. ConocoPhillips (NYSE:COP) cut its quarterly dividend from 74 cents to 25 cents, for the first time since 1991, which is proof that the yields might not remain at the current levels going forward.
Hence, sustaining the dividend yields in the future will depend on the price appreciation in crude from the current levels. If crude oil prices average closer to the EIA forecast, chances are that dividends will take a hit, but if prices appreciate considerably from here, investors will be handsomely rewarded for their risk.
Investors having a strong gut to withstand the volatility in crude oil prices and willing to accept lower dividend yields in the future should buy oil stocks on declines.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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