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By Josh Peters, CFA and Jeremy Glaser | 03-09-2016 03:00 PM

Dividend Investors: Are Energy Stocks Worth the Risk?

Dividend-seekers must question whether the oil majors can generate the long-run growth needed to compensate for their risks, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Oil majors like ExxonMobil and Chevron have been seen as relative bastions of safety in the tumultuous oil market. I'm here with Josh Peters, editor of Morningstar DividendInvestor, for his take on their dividend-paying potential.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: ExxonMobil and Chevron recently held analyst days. When you look at their positioning in the market right now, do you still think they are going to be able to withstand the turmoil we've seen in energy?

Peters: A lot of it, unfortunately, comes right down to the oil price, and if you're at sub-$40 oil, even Exxon may run a deficit after it's paid its dividends. It's not going to generate enough free cash flow in order to fully fund that dividend.

Now over a shorter period of time, a couple of years, if oil prices don't recover, what you have with Exxon and with Chevron--I own and have owned Chevron for a number of years; I haven't owned Exxon before--they have the balance sheet capacity to finish their big capital projects. Capex is going to fall; that's going to help cash flow. They have the ability to cut costs. They can do a lot of things at once. That's the advantage of having these very strong balance sheets in a cyclical industry going into the down part of the cycle.

At the end of the day, the most important margin of safety for these stocks is excess coverage for the dividend, either on a free cash flow basis or an earnings basis--I frankly would prefer both. At this point, both companies need a rebound in the oil price, in addition to all of the cost-cutting that they've put on the table in order to make these existing dividend policies work over the long run.

That's not the greatest position to be in from the standpoint of a dividend investor. I'd still rather be with these two names--one or other (again, I own Chevron)--than with ConocoPhillips, which has already cut its dividend, or BP or Shell. These are dividends that look very vulnerable to me.

Glaser: You mentioned cost-cutting. Do you think that spending less on capex is going to result in slower growth in the future? Is it going to restrain dividend growth?

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