Oil and natural gas are trading at historically low levels, which has been a huge problem for energy stocks like ExxonMobil (NYSE: XOM). Investors fear the worst, which in the case of ExxonMobil would include a dividend cut after more than three decades of annual increases. Those fears aren’t unfounded, but there are some things to consider before you let your fear get the best of you.
An incredible run
Exxon operates in an extremely volatile commodity-focused industry. The energy sector’s history is littered with periods of swift and dramatic oil and natural gas price swings.
The internationally diversified integrated-energy giant is well aware of that history, however, and has built a business that has, so far, been fairly robust in the face of adversity. Look no further than its string of 37 consecutive annual dividend increases for proof of that.
Image source: Getty Images.
But that streak is exactly why some dividend investors are worried today. In recent years, Exxon has been increasing its dividend in the second quarter. It didn’t do that in 2020, holding the dividend the same as the first quarter.
The first thing to note here is that the company’s annual streak isn’t broken. Because the first-quarter dividend in 2020 was larger than the first-quarter dividend in 2019, the dividend that investors receive will be slightly higher in 2020 if the company simply maintains it in the third and fourth quarters. And Exxon can maintain the increase streak into next year so long as the dividend is increased no later than the fourth quarter of 2021. The decision to hold pat in the second quarter doesn’t mean things have changed with regard to Exxon’s historical commitment to returning cash to shareholders.
In fact, during Exxon’s first-quarter 2020 earnings conference call, as CEO Darren Woods fielded a lot of questions about the dividend, he came back to a couple of key points. First, the company has not changed its opinion that returning cash to investors is a high priority. Second, the company hadn’t seen anything that would materially change its view of the long term for the energy sector.
Thus, despite oil prices actually falling below zero in the first quarter, Exxon hasn’t made plans to stop investing in its business or to change its dividend posture. It’s adjusting, including pulling back on some spending and holding the dividend flat, but it isn’t ready to travel down a completely new path. Indeed, as Exxon has noted in the past, energy transitions take a long time, and that means oil, despite the growth of renewable energy, will be vitally important to the world for years to come.
Some numbers to consider
That said, there are dividend indicators that investors should keep an eye on. For example, Exxon’s payout ratio in the first quarter was over 100%. So, too, was its cash dividend payout ratio, which looks at dividends relative to cash flow.
These are not positive signs, but the company’s historical commitment to the dividend suggests that it’s not the end of the story. Indeed, a company can use debt to support its dividend for some period of time. Companies can also sell assets to raise cash needed to pay its dividend. Exxon is trying to do both today.
Asset sales are difficult right now, but management has been selling non-core oil and gas properties in recent years to both upgrade its portfolio and generate cash for investment purposes. Meanwhile, financial debt to equity has increased from the low-to-mid teens in 2019 to roughly 36% at the end of the first quarter, as Exxon issued additional debt when COVID-19 started to spread across the globe.
Although that increases the company’s leverage, its balance sheet remains among the strongest in its global peer group. Exxon’s financial situation is definitely worse than it was at the start of the year, but it wouldn’t be accurate to suggest that Exxon has suddenly become a highly risky name in the oil patch.
The chart below shows financial debt to equity figures for several companies.
That’s highlighted by the fact that Exxon, despite the difficult market environment, still covered its trailing-interest expenses by 18 times in the first quarter. In fairness, that number has been heading lower and, frankly, will go lower still, being that it added a material amount of debt in the first quarter and oil prices are weak. But there’s still a lot of room on this metric before investors need to worry. The truth is, many of Exxon’s energy-major peers are in worse shape when it comes to leverage and interest coverage.
Watch, but don’t worry just yet
There are no guarantees in investing, so investors need to consider the notion that things have changed and Exxon might cut its dividend. So far, however, it’s doing everything it can to support the payout, including highlighting its importance to the company. In the end, it’s that commitment that will make the difference.
If you own Exxon for the dividend, there’s no reason to be overly concerned just yet. That said, you should start to keep a closer eye on the business, with particular attention paid to management’s comments about the future of the oil industry. If it starts talking about a long-term shift in industry dynamics, then the risk of a dividend cut will materially increase.
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