Oil Majors - Who Will Cut Their Dividend First?

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Includes: BP, CVX, TOT, XOM
by: Aristofanis Papadatos

Summary

While most of the oil companies have decimated their dividends, the four oil giants have not cut them.

TOT and XOM have the healthiest ratios and hence they are not likely to cut their dividend, at least for the next few years.

On the other hand, CVX and BP have leveraged their balance sheets to the extreme and hence they are likely to cut their dividends in the next 12 months.

Oil has been in a tremendous bear market during the last two years, losing 60% over that time frame, and hence most of the oil companies have been under great stress. While most of the oil companies, particularly those that are highly leveraged to the oil price, have already decimated their dividends, the four oil giants, namely Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), BP (NYSE:BP) and Total (NYSE:TOT) have not cut their dividends. As numerous shareholders hold these stocks for their high dividends, the big question is the sustainability of these dividends. As a side note, I predicted the dividend cut of National Oilwell Varco (NYSE:NOV) one month before its announcement.

In order to evaluate the sustainability of the dividends, one should check the key ratios, which are the dividend payout ratio and the net debt/earnings ratio. The former indicates whether a company earns enough to pay the dividend, with healthy ratios being below 60%-70%. The latter, which is used by Buffett, indicates how easily a company can service its debt, with healthy levels being below 10-15. The ratios have been calculated for both 2016 and 2017, based on the analysts' estimates for both years from finance.yahoo.com. The net debt has been calculated as per Buffett's formula: Net debt = total liabilities - cash - receivables (data from Morningstar.com). The figures are shown on the table below:

XOM

CVX

TOT

BP

Payout ratio 2016

124%

340%

82%

231%

Payout ratio 2017

68%

91%

55%

89%

Net debt ($B)

318,0

242,5

189,0

215,2

Net debt/Earnings 2016

31,3

102,9

24,4

69,0

Net debt/Earnings 2017

17,3

27,5

16,4

26,6

Exxon Mobil

Exxon Mobil has the second-best payout ratios and net debt/earnings ratios. While its dividend payout is much greater than its expected earnings this year, its payout ratio will revert to the much healthier level of 68% next year if the analysts' estimates are proven correct. However, as the analysts are currently estimating that the earnings will increase from $2.42 in 2016 to $4.38, it is evident that the estimates will turn out to be correct only if the price of oil strongly rebounds next year, at least above $60. Given the recent plunge of the oil price, there is a high risk that the payout ratio will remain elevated next year.

It is also worth noting that Exxon will spend about $20 B on capital expenses this year and a similar amount next year. Therefore, its expected earnings of $10 B this year will be clearly insufficient to support the $13 B dividends plus $20 B capital expenses so the balance sheet of the company will significantly weaken in the next few quarters. Nevertheless, given the relatively strong balance sheet of the company (compared to most of its peers) and the 30 consecutive years of dividend growth, investors can rest assured that the management will stretch the balance sheet as much as possible in order to avoid a dividend cut. All in all, a dividend cut is not on the horizon for this stalwart, at least for the next few years. This is also evident from the dividend hikes of the company during the last two years (4% per year on average) while the other oil majors have frozen their dividend.

Total

Total has the healthiest ratios thanks to the resistant profile of its earnings. More specifically, its downstream segment has provided excellent support to its results during the last two rough years and, even better, the earnings from this segment enjoy a preferential tax rate. That's why Total is the only oil major with a payout ratio below 100% this year. Therefore, its shareholders, who enjoy a current dividend yield of 5.8%, should remain confident that the dividend will not be cut in the foreseeable future unless its management becomes extremely conservative.

Chevron

If Exxon is stretching its balance sheet to maintain its streak of dividend growth streaks, Chevron is stretching it to the extreme. The company pays an annual dividend $4.28 per share while it earned only $3.38 last year and is expected to earn $1.26 this year. Even worse, the company has posted a loss of $2.2 B in the first half of the year so it is really doubtful that the company will meet the analysts' consensus this year. Even if one excludes the $2.4 B of net asset impairments, the earnings of the company are almost zero per share so far this year. Moreover, Chevron will spend about $20 B (about $10 per share) per year on capital expenses this and next year so it is really amazing how the company keeps paying its excessive dividend.

Of course the answer is that Chevron has been adding debt at an unprecedented pace in the last 2 years. More specifically, its net debt has climbed from $215 B in 2013 to $242 B this year. It is obvious that the company cannot keep adding debt to maintain its dividend. On the other hand, Chevron has not cut its dividend for 30 years so its management is doing its best to avoid the painful decision of breaking the streak. If the price of oil shows signs of a strong rebound, above $60, then the company may maintain its dividend for a few more years. However, if the price of oil does not show any signs of a recovery within the next 12 months, the management will be forced to cut the dividend.

BP

BP has been bleeding cash at a higher rate than its peers due to the aftermath of the Macondo accident. The company is paying more than 2 times its earnings to its shareholders this year and its payout ratio will remain at extreme levels even if the optimistic estimates turn out to be correct next year. BP will also keep paying $1 B per year for the next 18 years for the settlement of the accident. Therefore, it is evident that its dividend is unsustainable. Its management is waiting for the painful decision hoping for a strong recovery of the oil price but, if the latter does not materialize, the dividend will be cut.

Since the accident, the management executed an unprecedented asset sale program to support the dividend. To be sure, the company sold almost $50 B of assets in the aftermath of Macondo. However, the divestment program has reached its limits and hence the asset sales will be only about $5 B this year and about $2.5 B per year from next year, clearly insufficient to support the annual dividend of $7.2 B and the massive capital expenses of ~ $17 B per year. The management is clearly postponing the inevitable dividend cut because the long-term shareholders have already suffered much due to the accident in 2010. However, BP has a very week balance sheet and will be the first to cut its dividend if the oil price does not show any positive signals. In the end of the day, BP temporarily eliminated its dividend in 2010 so it does not have an exceptional streak to maintain, as opposed to its American peers.

Conclusion

To sum up, while the oil majors have not cut their dividend yet, the financial stress from the collapse of the oil price is evident in their balance sheet and the above mentioned key ratios. Total has the healthiest ratios and hence it is not likely to cut its dividend any time soon unless its management becomes extremely conservative. Exxon Mobil has ample room in its balance sheet to keep adding debt so it will almost certainly avoid the dividend cut, at least for the next few years. On the other hand, Chevron and BP have been bleeding cash at an unprecedented pace so they are likely to cut their dividend if the oil price does not rebound above $60 in the next 12 months. Given the additional stress of the aftermath of Macondo on BP and the absence of a dividend growth streak, BP is likely to be the first to cut its dividend in the next 12 months.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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