Integrated Oils' Yields Are Spiking. Are Dividends Safe?
It's likely to be a tough few years, but dividends should remain intact, meaning opportunity exists.
Integrated oils have fallen out of favor with investors in the past year as macroeconomic headwinds have depressed earnings across the entire portfolio, a rare occurrence. Difficult conditions are likely to persist in 2020 and 2021 as lower demand results in not only lower oil and natural gas prices, but also narrower margins on refined products and petrochemicals. However, at $30 a barrel currently, the Brent oil price sits well below our midcycle price estimate of $60/bbl, leaving the group trading at a steep discount to our fair value estimates. The recent sell-off has created a spike in dividend yields as well. We think concerns about dividend sustainability are largely misplaced, despite oil being below break-even levels, given the companies’ ability to lean on balance sheets in the near term as well as eventual capital expenditure reductions and potentially the reintroduction of the scrip dividend option.
Low Oil and Natural Gas Prices Not the Only Problem
Before the drop in commodity prices over demand concerns related to the coronavirus outbreak and supply concerns from a breakdown in OPEC+ talks, integrated oil shares were already under pressure as most companies reported weak 2019 earnings in a difficult macroeconomic environment. Typically, one benefit of the integrated model is the countercyclicality of its upstream and downstream (refining and marketing and chemicals) segments, which offer cash flow support through a variety of price environments. Both segments registered earnings declines in 2019, however, leaving integrated companies suffering from not only weak oil and natural gas prices, but also narrow refining and chemical margins, driving a 25% average earnings decline for the year.
Allen Good does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.