Update: July 28, 2015. Statoil (STO) reported second quarter results today (July 28) that beat consensus estimates on both earnings (NOK3.15 a share vs. the NOK1.62 consensus) and revenue (NOK138.5 billion vs. NOK124.8 billion analyst consensus.)
That doesn’t mean Statoil has found some way to magically sell oil for a higher price than competitors. Second quarter earnings may have exceeded analyst estimates but they still fell 27% year over year.
What’s the secret to the Norwegian oil company’s relative success at a time when oil continues a collapse from $108 a barrel in January 2014 to a July 28 close at $53.15 (for European benchmark Brent crude)?
Statoil’s quarter is a checklist for what an oil company has to do right these days to stand a chance of navigating a plunge in oil prices that still has a while to run. (Statoil is a member of my Jubak Picks portfolio. The position is down 36.4% since I added it on May 10, 2012. )
First, Statoil announced a further cut to its capital-spending budget to $17.5 billion for 2015. That’s down from $20 billion in 2014 and a projected budget of $18 billion reported last quarter. At the same time as the company continued to cut capital spending production climbed with second quarter production, adjusting for asset disposals, up 7% year over year.
Second, Statoil has been able to cut costs—and increase efficiency—so that it is finding and producing more oil even with lower capital spending. Unplanned losses (that is production losses that aren’t the result of planned events such as maintenance but are the result of accidents or weather) have fallen from 12% in 2012 to 5% in 2014. Efforts to increase the percentage of oil recovered from mature and declining off shore fields on the Norwegian Continental Shelf have pushed the recovery factor up to 50% with the company targeting 60% recovery. (Increasing oil recovery is an especially profitable endeavor since the company has already built out necessary infrastructure in the region.) Operating expenses fell an additional 15% quarter to quarter.
Third, Statoil has either been very lucky or very good at finding new oil to diversify its asset base beyond its traditional concentration in the Norwegian Continental Shelf. The company has announced promising finds in the deep-water Gulf of Mexico, off the east coast of Canada, and off both coasts of Africa (Angola and Tanzania.) Statoil has also recently added U.S. shale assets in the Marcellus, Eagle Ford, and Bakken geologies.
All this is backward looking, of course. Looking toward the future, Statoil has potentially lucrative positioning as a major supplier of natural gas to Europe at a time when Western European countries are looking to reduce their emissions of green house gases and to find alternative sources of natural gas to reduce reliance on Russian supplies.
Looking that that same direction, the big uncertainty is whether Statoil can continue to reduce costs and increase production at rates that will enable the company to maintain the current $0.221 quarterly dividend. Right now the company’s payout ratio is running at 80% to 100%, which doesn’t leave Statoil with a huge margin for further drops in the price of oil. In the conference call, the company said that it projects that it can maintain the current dividend payout (for 2015, management said) while reducing the payout ratio. The stock currently yields 5.4%.
As of July 28, looking at the likelihood that oil prices will stay low for a while, I’m cutting my target price to $24 a share by June 2016 from a prior $28 a share. Statoil closed at $16.48 in New York trading on July 28.
Normally I look for dividend yields above 4% or 5% for my dividend income portfolio.
On this measure, Exxon Mobil (XOM) with its 3.35% yield isn’t exactly an astounding opportunity.
But something out of a recent report from Goldman Sachs caught my eye: Exxon Mobile (XOM) will be “the only U.S. or European major that can generate sufficient free cash flow to cover its dividend near $60 a barrel in 2016-17.” While other oil majors, Goldman continues, will be struggling to keep the dividend flat, Exxon Mobil will be in a position to increase the dividend for the next several years.
Goldman is, at the moment, extremely bearish on oil prices, lowering its forecast in the last few days to an average in 2015 of $58 a barrel for Brent and $52 for West Texas Intermediate. (Brent closed at $66.54 a barrel today, May 21, while West Texas Intermediate closed at $60.72 a barrel.) But while you probably think (as I do) that Goldman’s forecast is too pessimistic, I would make the point that oil prices could well stay at $70 or less for a while. And in that environment, oil companies aren’t going to be awash in cash for distribution to shareholders as dividends or buybacks.
Except for Exxon Mobil.
Standard & Poor’s has recently made the same point. “We see 2016 operating cash flow well in excess of capital spending, raising flexibility for returns to shareholders.”
And so has Morningstar: We “continue to see the dividend as the safest of all of the
oil majors” with a significant step up in free cash flow by 2018
A decent yield now, a safe yield going forward, and the prospects of continued dividend growth even during this period of depressed oil prices. (Exxon Mobil has grown its dividend at a 10.5% annual rate over the last five years.) Sounds like a good deal for income investors to me. I’ll be adding ExxonMobil to my dividend income portfolio tomorrow May 22. The shares closed at $87.21 today, May 21. The 52-week high/low range is $104.76 to $82.68 a share. (Exxon Mobil is already a member of my Jubak’s 50 long-term stock portfolio.)
So where does all this cash flow come from?
Partly it’s a result of Exxon Mobil winding down the capital spending stage on seven big projects that will go on line this year. (That is they will shift from eating cash to producing it.) And partly it’s a reflection of Exxon Mobil’s downstream strength. The company’s profit from its refineries doubled year over year in the first quarter. Low oil prices certainly hurt profits in the company’s up stream production business but they push up profits as refineries can buy crude at bargain prices. Despite distributing $3.9 billion to shareholders in the first quarter, Exxon Mobil’s cash position grew by $500 million in the period.
Of course, if Goldman is wrong and oil prices finish stronger in 2015 than projected, Exxon Mobil (and dividend investors) ought to do okay too.
Update January 20: Income investors are intensely watching dividend changes in the energy sector.
Before the plunge in oil prices, energy stocks attracted lots of dividend money because the sector was one of the few places where you could get a 5% return.
Of course, now, plunging oil prices have put those dividends at risk. The damage has been clearest in the oil service sector where SeaDrill (SDRL) cut its dividend completely and where shares of companies such as Ensco (ESV) and Transocean (RIG), now yielding 9.9% and 18.8%, respectively, are trading as if their dividends are in danger. (More on SeaDrill and Ensco in the next few days; both stocks are members of my Dividend Income portfolio http://jubakam.com/portfolios/ )
Is the damage about to expand to take in energy master limited partnerships in pipelines and sand for fracking? So far the evidence says No. But that answer is by no means definitive. What we’ve been seeing over the last few weeks has been limited but significant increases in dividend payouts by the solid companies in this group.
So, for example, on January 15, fracking sand MLP Hi-Crush Partners (HCLP) announced that it would raise its payout by 8% to 67.5 cents a unit from 62.5 cents. (The record date is January 30 and the payment date is February 13.)
I don’t think this means Hi-Crush is out of danger—or that the shares are about to immediately recover to the $65 range of last September from the current $37 a share price on January 21. There is just the little issue of whether the slowdown in drilling activity in the U.S. oil and natural gas shale geologies will cause a bigger than expected drop in sand volumes and prices. We’ll have a better feel for that when Hi-Crush reports earnings and revenue on February 5.
What I really want to know as I prepare to collect another 6.95% payout from Hi-Crush is whether that “impairment” in the share price is temporary or permanent—and how temporary it might be. Hi-Crush is a member of my Dividend Income portfolio.
I’m going to use today’s (July 18) rather surprising upward move in US stocks-despite a big upswing in market nervousness yesterday-to sell Pfizer (PFE) out of my Dividend Income portfolio http://jubakam.com/portfolios/jubak-dividend-income/. (The Standard & Poor’s 500 index was up 0.96% as of 3:00 PM New York time.)
After the failure of the big drug company’s efforts to buy AstraZeneca (AZN), Pfizer seems a cash cow without a strategy. Not that the attempt to buy AstraZeneca was birilliantly creative-the deal would have let Pfizer move its tax-jurisdiction to the United Kingdom from the United States for huge savings. But it wouldn’t have done much if anything to fix the combination of ineffective research and expiring patent protections (Celebrex, the company’s $2.9 billion (in 2013 sales) arthritis blockbuster, is scheduled to go off patent in 2015) that are projected to slow sales growth to a crawl. Morningstar projects Pfizer’s sales growth at 1% a year over the next decade; share buybacks will raise earnings per share growth to 3% a year. In its year-by-year earnings per share projections, Credit Suisse calls for earnings per share to grow to $2.24 in 2014 from $2.22 in 2013, and then to $2.30 in 2015, and $2.61 in 2016.
Even with a 3.4% current dividend yield, those projected growth figures don’t add up to much in the way of upside capital appreciation.
If all I was looking for at the moment was safety, however, I’d consider hanging onto Pfizer.
But the combination of rising nervousness-the VIX volatility index climbed by 32% yesterday-and a rise in geopolitical tensions argue that I’d like to have a little cash on hand in case events in the Ukraine or in Gaze over the next few days result in a drop that might give me a buying opportunity in a dividend stock with a higher yield and better prospects for capital gains.
I would also probably hang onto Pfizer if I didn’t have a good replacement up my sleeve-but I do (and I’ll tell you what it is next week) and so it’s time to sell with a small 0.63% loss in share price (made up for by that near 3.5% dividend) since I added these shares to the Dividend Income portfolio back on February 6, 2014.
The stock goes ex-dividend on July 30 in case that income in hand (as opposed to capital locked up in the share price) is important enough to lead you to think about putting off a sale. (Share prices do tend to drop after the payout to match the dividend payout. Otherwise, if you think about it, dividends would create value for investors out of what is actually a distribution of cash that lowers the balance in a company’s treasury and raises it in shareholder wallets).
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.
There’s increasing reason to believe that the Treasury market has stabilized on the fundamentals—until the next panic when the Federal Reserve again begins to talk as if a decision to taper off its program of buying $85 billion a month in Treasuries and mortgage-backed assets is just around the corner.
And if the Treasury market has stabilized, it means that the weakness in dividend stocks (calling it a sell off would be an overstatement) is at an end—for a while—too.
The latest piece of evidence comes from a Wall Street formula called the term premium, which measures the risk of holding long-term bonds by factoring in the market’s outlooks on inflation and economic growth.
If you assume that consumer inflation will continue for the rest of 2013 at something like the current low rate–the lowest rate since 2009; and if you assume that U.S. economic growth will stumble ahead for the rest of 2013 by something like 2% or so rather than “racing” ahead at 3%, then the current 10-year Treasury yield of 2.54% is about right.
The long-term reading on the term premium has been an average reading of 0.40% in the decade before the financial crisis in 2007. It’s now at 0.46%, according to Bloomberg. As recently as May 2013 the term premium was a negative 0.5%. The term premium has been in negative territory since October 2011 and turned positive only in June 2013.
What does all that mean? The term premium is the extra yield that investors require before they will buy a long-term bond instead of a series of short-term bonds. If, for example, the yield on a 10-year Treasury were 5.5% and holding a series of 1-year Treasury bills over the next 10 years would be expected to yield 5%, then the term premium would be 0.5 percentage points or 50 basis points.
In most periods you’d expect the term premium to be positive since investors would, normally, require extra yield to induce them to hold a longer-term bond. But under some circumstances the term premium would be negative. If, for example, investors wanted to lock in a long term yield instead of taking on the risk of rolling over shorter term bills—with the chance that interest rates might be lower on each subsequent roll over—then the term premium could well be negative. That is indeed why the term premium was negative in early 2013—bond buyers actually preferred locking up their money for the long term instead of taking the risk that short-term interest rates might fall for subsequent rollovers. It wasn’t necessarily that yields on 10-year Treasuries were so attractive in comparison to short-term yields. It’s just that they were preferable given the assumed unpredictability in short-term yields. Predictability is a valuable commodity for pension funds and insurance companies that want to match the timing of their cash outflows and the timing of their cash inflows.
The big reason that bond buyers have started to see 10-year Treasury bonds as fundamentally attractive again—aside from their big recent drop in price and rise in yields—is the absence of any signs of inflation. Look around the globe—can’t find it. Can’t even find a scenario that might produce it relatively soon. At current economic growth rates, the global economy is awash in capacity whether it’s capacity for manufactured goods or production capacity for commodities. With China’s economy slowing that global overcapacity doesn’t look likely to go away quickly. (The one exception to this pattern of modest inflation is, perhaps, food commodities but even there the potential for a record harvest this year has pushed down near-term prices.)
Real yield on the 10-year Treasury—that is the yield once you subtract current inflation—is 1.56 percentage points, the highest level since March 2011. As recently as November, real yields were negative.
This hasn’t been a great first half for Treasuries and other bonds. Treasuries, according to the Bank of America Merrill Lynch bond index, lost 2.48% in the first half of 2013, the biggest loss since 2009
But Wall Street now believes that bond prices have stabilized within a likely range for the 10-year Treasury of 2.4% to 2.8% for the rest of 2013. High levels of bond market volatility and the uncertainty over when the Fed might begin The Taper argue that bonds yields aren’t going back to former lows, however.
What does this mean to you? Read more