Oil Stocks: Drilling for Dividends


NEW YORK (TheStreet) -- Fears of a global economic recession have caused many investors to steer clear of oil stocks, but the dividend yields on shares of some of the big players in the sector are worth a second look.

Three stocks in particular stand out:

Exxon ( XOM), ConocoPhillips ( COP)and BP ( BP) are currently yielding 2.61%, 4.22% and 4.67% respectively. Those payouts compare quite favorably to the 1.87% yield on 10-year U.S. Treasury bonds, which is barely above 1% for investors subject to ordinary income tax rates.
Exxon

"Each of these oil stocks offers a meaningfully higher yield," says Luminous Capital partner Alan Zafran.

"In the case of Exxon Mobil and ConocoPhillips, the companies have a history of steadily raising their dividends to their shareholders. In the case of BP, the company's shares are still trading at a meaningful P/E (price-to-earnings) discount to its peers in the aftermath of the oil spill in the Gulf of Mexico, a discount that is too harsh in our opinion."

BP's five-year dividend growth rate has been -11% when factoring its dividend suspension last year to pay for costs related to the Gulf of Mexico oil spill, but the company reinstated it in February. Exxon's dividend growth rate over the last five years has been 7.8% and ConocoPhillips' has been 12.7%.

"Given the higher yields and projected earnings growth of these companies, as reflected in bullish sell-side price targets, what would you rather own?," asks Zafran.

The biggest risk to investors of these stocks, of course, is if the global economy plunged into another recession and demand for oil plummeted, there could be a meaningful reduction in earnings in the next year or two.

But Zafran says assuming that the recession is shallow and not prolonged for too long, the dividends are unlikely to be reduced. In fact, in the 2007-to-2008 recession, all three of these companies increased their dividends. "In these three cases, earnings could fall by 50% and the companies would still be generating earnings in excess of their current dividend payouts," Zafran pointed out.

Phil Weiss, senior energy analyst at Argus Research, says that given Exxon's relatively low yield -- easily the lowest among the majors that he covers -- and its general hesitancy to cut dividends, the company would likely cut its stock buyback plan before it would touch the dividend in the event of a global recession. "Plus, the balance sheet is strong and the payout ratio low."

Investors, of course, typically have little tolerance level for dividend cuts.

"ConocoPhillips also has a lot of money dedicated to its buyback program and a relatively low payout ratio, so I'd think a cut would be unlikely for it as well," Weiss adds.

BP, on the other hand, says Weiss, is "somewhat more problematic" in that it currently doesn't have a buyback program that companies often used to increase the values of their shares outstanding. Dividend yields, of course, largely depend on share prices.

That said, Weiss notes that BP's asset sales have helped the British oil giant build a formidable cash position and that it's unlikely to cut from a dividend that was just reinstated.

"Based on their financial position, I don't see a reason at this point to think any of these companies would be contemplating a dividend cut," he says.

Benchmark analyst Mark Gilman says Exxon's dividend isn't vulnerable to any reductions unless oil prices retreat and stay at a level equal to or below $30 a barrel -- which is highly unlikely.

Though he cautions that BP and ConocoPhillips' dividends are "special situations" because of the oil spill liability issue and pending corporate split, respectively, "generally, major oil dividends are unlikely to be impacted negatively by a cyclical downturn in the global economy."

-- Written by Andrea Tse in New York.

>To contact the writer of this article, click here: Andrea Tse.

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