Yield, Value, Safety - Available With (Some) Integrated Oils

by: John D. Thomason

This is a continuation of the series of searching for stocks with the above listed attributes suitable for an income portfolio, this time focusing on major integrated oil companies. In this article, I will present how I approached the task of narrowing down the choices available in this grouping, and what I believe to be the best selections available at the moment. Based on traditional valuation metrics, the stocks in this sector offer good values in nearly every case, with some offering exceptional values. Looking beyond the numbers, there are reasons for some of the exceptional valuations. This sector, more than most, is subject to considerable political risk.

At the outset, I must state that my I spent my entire career as an IT analyst and manager with two oil companies, and I am somewhat favorably biased towards the sector. Further, in the interest of full disclosure, note that I am not a financial professional, nor am I certified in any way as a financial advisor. I am an independent, individual investor, focusing on dividend-paying stocks, exclusively.

In reviewing the fundamentals, one is struck by the financial strength these firms possess. About the only business risk is the remote possibility of a precipitous, sustained drop in the price of crude oil and refined products. While the current nadir in natural gas prices in the U. S. probably has had some effect, the impact across the group is not a major factor, in my opinion, as far as the investment attractiveness of these stocks is concerned.

As was the case in my previous articles in this series, most of the data was obtained from the MSN Money website, which I refer to repeatedly as the "primary source website". I used the TD Ameritrade website, available to me as an account holder, for dividend data. The Morningstar ratings data came from www.morningstar.com, which provides basic data without charge, with registration. Other ratings data came from resources available to me as an account holder with E*Trade, TD Ameritrade, Schwab, and Fidelity.

I used the E*Trade scan feature, available to me as an account holder, to perform my initial scan. To begin the search, I scanned for companies in the Energy: Oil & Gas Integrated, sector, with the only qualifier being yield, which had to be at least 3.00%. I added back Exxon Mobil (XOM), which I wanted to include regardless of yield, and PetroChina (PTR), which I felt should be included, even though E*trade considers PTR to be in the Energy: Oil & Gas Operations sector. At this point, I had identified 13 firms. Next, I eliminated two foreign firms, YPF Sociedad Anonima (YPF) and Repsol YPF A (OTCQX:REPYY), based in Argentina and Spain, respectively, as the political risk appears to be moving from potential to actual, per news that has come out just in the past few days; the Argentine government has announced plans to take control of YPF, either by expropriation or by purchase of a controlling stake. REPYY owns 57% of YPF, so the news affects both firms.

I thus ended up with only 11 companies to review, which are:

Exxon Mobil (NYSE:XOM) - U.S. based, Irving, Texas.

Chevron (CVX) - U.S. based, San Ramon, California.

ConocoPhillips (COP) - U.S. based, Houston, Texas.

Royal Dutch Shell Class B (RDS.B) - Dividends paid on B shares are treated as United Kingdom-based for withholding tax purposes, and no withholding occurs for U.S. shareholders.

BP plc (BP) - Based in the United Kingdom, no withholding for U.S. shareholders.

Total S.A. (TOT) - Based in France, withholding of 25% applies.

ENI S.p.A. (E) - Based in Italy, withholding of 27% applies.

Statoil ASA (STO) - Based in Norway, withholding of 15% applies.

Petroleo Brasileiro SA (PBR) - Based in Brazil, withholding of 15% applies, according to my data source. I have not owned PBR, so I have not personally experienced the withholding being applied.

PetroChina Co LTD - Based in Beijing, China, withholding of 10% applies, according to my data source. See PBR, above, for further information.

LUKOIL (OTCPK:LUKOY) - Based in Moscow, withholding of 15% applies, according to my data source. See PBR, above, for further information.

I reviewed the firms from the standpoint of the same six criteria sets as the previous articles: dividends, revenue and earnings, debt, returns, valuations, and ratings. The results are presented in six tables:


The first criterion set is all of the key metrics relating to dividends. In addition to the current yield, I reviewed the last five years of dividend history, and calculated the dividend growth experienced over the period, for the firms with a steady, growing dividend. I also show, for informational purposes, the payout ratio and the ex-dividend date (month and year) of the last increase.


The next criterion set is earnings and revenue, which is the foundation upon which dividends are based. If earnings and revenue are lacking, dividends cannot be sustained for long. I reviewed the operating cash flow vs. net income for the last five years and the last five quarters, to see if cash flow consistently exceeded net income, which would indicate high-quality earnings. The table indicates the number of periods, out of five possible, that cash flow exceeded net income. Thus, 5/5 is an ideal reading. I also reviewed the ten year histories of revenue and net income, to get an idea as to the stability of revenue and earnings, and also debt. The ideal case would be steadily increasing revenues and net income, and flat or declining debt. While revenue and earnings were mostly stable, nearly all of the firms experienced a dip in net income in 2009, coincident with the financial crises. Another data item shown is the consensus five-year earnings growth forecast estimates from analysts. Finally, when available, the S&P earnings quality rating is shown.

DEBT (Table 3)

These companies carry less debt than the typical corporation today. Long-term bond ratings from S&P, Moody's, and Fitch were only available for the three U.S. majors, which, not surprisingly, were rated very highly. Debt ratios of leverage, debt to equity, and interest coverage were taken as shown from the primary source website. Long-term debt percentage of total capitalization and stockholder's equity percentage of total capitalization were calculated from the most recent balance sheets available. Since in several cases the firms had significant non-current liabilities besides long-term debt, I added a new metric for comparison purposes, the percentage of total capitalization represented by total non-current liabilities.

RETURNS (Table 4)

Return on equity, return on assets, and return on capital, as taken from the primary source website, are shown.

VALUE (Table 5)

Valuation ratios of price to earnings, price to book value, price to sales, and price to cash flow are shown. These stocks still offer surprisingly good values; even the U.S. firms, which have experienced hefty share price increases over the past year or two. The results shown are based on the prices prevailing early in the week of April 2, 2012.

RATINGS (Table 6)

I mainly relied upon my favored resources of S&P and Morningstar. Since Schwab evaluates some foreign firms, I included Schwab's rating, if available. Also shown is the analysts' composite rating, presented as a numerical average, which came from the primary data source website. The number of analysts included in the rating average is indicated.

Conclusions and recommendations:

After reviewing all of the data, these stocks seem to me to fall into three groups:

Group 1, U.S. Majors - offering decent yields, still available at value prices, though less so than a year or two ago, and the safest of the three groups. The companies are Chevron , Exxon and ConocoPhillips . Even with these firms, all is not completely tranquil. CVX has been in the news lately, as a tiff continues with Brazil over an oil spill. COP has muddied the water, in my opinion, with their announced plan to break up into two companies, with refining and marketing businesses going to one, and exploration and production activities to the other. Finally, investors in these firms should at least be aware of the thinking of Jim Chanos, the noted short-seller that identified Enron's problems early-on. He has stated that these firms are in effect liquidating themselves, as they continue to fall short in replacing reserves, and see their cash flow being consumed by increased capital spending, as they seek reserves in ever-more-forbidding terrain. At least, this is what was stated in a January 2010 article from Business Insider, viewable HERE. I will grant that the firms are having a hard time replacing reserves, but I just don't see the situation as being as dire as the article suggests. One data item that was interesting to me was that the returns of the U.S. firms XOM and CVX were substantially better than all of the other firms. COP's returns were not up there with the other two U.S. firms, as COP is still recovering from some poorly-timed acquisitions from the first decade of the new millennium.

Group 2, European Majors - offering excellent yields, also available at decent valuations, and still reasonably safe. The companies are Royal Dutch Shell, B shares , Total S A , ENI S P A , Statoil , and with an extra asterisk or two, BP PLC . TOT has been in the news lately, as a natural gas leak at a North Sea platform has required an evacuation, and is costing TOT around $2.5 million a day. The news has resulted in a buy opportunity for TOT shares, which have dropped around $5 since the news broke. E is recovering, as the Libya situation had affected the firm. Based on the numbers, BP appears to be recovering from the Macondo platform oil leak disaster, but it will be years before all the litigation is settled. While BP has resumed dividends, the ability of BP to pay or increase dividends could be impacted for a long time. An investment in BP for the dividend is like buying stock in a tobacco firm - it is a bet that pending litigation will not result in the dividend being compromised. Also, these firms, similar to the U.S. majors, all face the same problem of replacing reserves. I personally favor all of these firms except BP, which I am avoiding. I believe E, TOT, STO, and RDS.B all offer better yields than the U.S. firms, even after considering tax withholding; are available at valuations as attractive as the U.S. firms, if not better; and are almost as safe, although one must adjust to the annual and semi-annual payment schedules, in the cases of STO and E, respectively.

Group 3, Non-European Majors - offering excellent yields, unbelievable valuations in some cases, but then comes the catch; they cannot be considered safe. Political risk trumps all metrics, in my opinion. The companies are Petroleo Brasileiro , Oil Co Lukoil (OTCPK:LUKOY), and PetroChina LTD . In each case, the host country government is substantially involved in the operation of the firm. Enough said, I would hope.

My final recommendations:

Possible Buys: TOT below $50, E below $45, STO below $26, and RDS.B below $70. Upon a general market decline, CVX below $100. With a low dividend, I would not consider XOM unless it dropped below $70. All figures are indicative of a range where I would find value, and are not to be taken too literally.

Pass For Now: COP, with the spin-off issue creating uncertainty for the stock, and BP, with Macondo litigation still ongoing. I would prefer to avoid these complications.

Pass, Probable For Now and Forever: LUKOY, PTR, and PBR. Investing in these stocks is trusting your investment to governmental actions of Russia, China, or Brazil, respectively.

Pass, Definitely For Now and Forever: YPF, REPYY. Maybe Argentina is still upset over the Falklands. At any rate, there is overwhelming political risk here.

Disclosure: I am long (NYSE:TOT), (NYSE:E), (STO).