So naturally, many conservative investors living off dividends are wondering how safe this legendary oil giant’s dividend really is.
Let’s take a look at why, and how, Exxon plans to ride out this oil storm, and not just maintain the current payout, but also continue growing it as it has for over a third of a century.
ExxonMobil is the world’s largest publicly traded integrated oil company, meaning it profits from extracting value from every stage of oil production, refinement, and transformation into specialty petrochemicals.
Source: ExxonMobil Investor Presentation
During the first half of 2016 the company produced the equivalent of just over 4.1 million barrels per day of oil, 58.8% of that in the form of higher margin liquids, such as crude oil, and the remainder in the form of natural gas. To put that in perspective, if Exxon were a nation, it would be the fifth largest oil producer on earth; ahead of Canada, Iran, Kuwait, the UAE, and Venezuela.
Source: US Energy Information Administration
What’s more, with 25 billion barrels of proven oil reserves, Exxon would hold the 14th largest reserves of any nation on earth; more than Mexico, and Brazil combined.
Source: CIA World Factbook
During the first two quarters of the year Exxon’s refineries produced 4.2 million barrels per day of gasoline, diesel, and jet fuel, much of which made up the 5.4 million barrels per day of refined oil products Exxon sold around the globe via its diverse network of gas stations.
Finally, as one might expect, Exxon’s specialty chemical division is equally massive, producing 12.5 million tons of high-margin petrochemicals in the first half of 2016. The chemical division is helping to offset much of the financial pain through this most challenging of energy markets.
In fact, thanks to how low oil prices have fallen, actual oil production made up the smallest contribution to the company’s earnings during the most recent quarter.
|Business Segment||Segment Earnings||% of Earnings|
|Upstream (Production)||$294 million||17.3%|
|Downstream (Refining)||$825 million||48.5%|
The key to Exxon’s long-term investment thesis is its world class management, led by CEO Rex Tillerson, who has been with Exxon since 1975 when he began working as a production engineer.
Over his 41-year tenure, Tillerson has lived through numerous boom bust cycles in the energy industry and has helped to instill a highly conservative and hyper-efficient corporate culture at Exxon.
Exxon’s integrated business model also enables it to react more effectively, efficiently, and quickly to changes in the business environment. The company’s diverse asset base provides market optionality and operational flexibility while allowing Exxon to optimize profits throughout various commodity cycles better than most of its peers.
The company’s scale further helps it maintain lower costs than its peers. For example, Exxon’s Downstream and Chemical businesses generated over $50 billion in earnings over the last five years, nearly twice as much as its nearest competitor.
Exxon’s return on capital employed averaged 18% over the past five years, which is close to five percentage points higher than the next closest competitor as well. Management has done an excellent job allocating capital to create economic value.
Looking ahead, the company’s massive resource base of 91 billion oil-equivalent barrels provides sold visibility. Exxon has a long reserve life of 16 years at current production rates, which leads all competition.
Perhaps more importantly, Exxon’s track record of profitably replacing its resources is outstanding. Like clockwork, Exxon has added around 1.5 billion to 2 billion oil-equivalent barrels of resources to proved reserves each year, replacing more than 100% of production for more than two decades.
Under Tillerson’s guidance, Exxon has consistently produced the lowest costs and highest margins of any of its integrated oil major rivals.
This combination of laser-like focus on cost controls, along with the best economies of scale, have resulted in an impressive track record of industry leading profitability.
Better yet, management is well aware that Exxon’s shareholder base is dividend and dividend growth focused. And since this is a highly cyclical industry, the key to long-term dividend growth over time is using the windfall profits of the boom times to return capital to shareholders in the form of large buybacks that bring down the share count over time.
By reducing the share count by 2.6% per year over the past five years, Exxon decreased its dividend burden and helped keep the payout ratio, allowing for more secure dividends during the lean times. Better yet, it also helps Exxon to generate far better long-term dividend growth than its rivals.
Overall, Exxon’s capital discipline, quality assets, integrated operations, diverse resource base, and scale will continue to serve the company well for many years to come.
There are four key risks to be aware of when investing in Exxon.
First and foremost, never forget that oil & gas prices are highly volatile and cyclical in nature. And as this oil crash has showed us, no one can predict the short-term fluctuations of energy prices, or how long they might remain low.
While management has shown itself the best in the world at cutting costs and squeezing out maximum profitability from its assets, there is only so much cost cutting that can be accomplished in a sustainable fashion. After all, oil fields naturally decline in production over time and require a minimum amount of maintenance investment to keep the oil flowing.
So the largest risk to Exxon is that oil & gas prices remain at suppressed levels for several more years. Ironically, this risk is increased because of the very efficiency gains that Exxon and its rivals have accomplished in the last few years.
For example, thanks to new and improved fracking technology, such as more advanced drilling rigs, horizontal drilling, longer laterals, more fracking stages, and increased use of frack sand, production costs have fallen to levels that allow cash flow break even at much lower oil prices than previously believed possible.
And thanks to over 3,900 drilled but uncompleted, or DUC (i.e. not yet fracked), wells in the US, shale producers could very quickly ramp up US production once oil prices rise even a little.
In fact, in the last few months, when West Texas Intermediate, the US oil standard, rose above $50 per barrel, we’ve seen a surprising number of rigs once more start drilling. Specifically Baker Hughes (BHI) just reported that the number of US drilling rigs rose for the third straight week, and the eighth increase in 10 weeks, to 524. That’s compared to a May low of 406.
And since each rig is able to drill more efficiently, there is always the risk that US shale oil will become a fast-paced swing producer, which increases production quickly as oil prices potentially rise due to OPEC’s recent agreement to cut production.
In other words, US oil producers might end up raising production as OPEC supply declines, capping the rise in crude to around $55 to $60. While that would be a big improvement to recent years, and a continued boon to global energy consumers, it would do no favors for Exxon’s balance sheet.
In fact, S&P (SPGI) recently downgraded Exxon from its coveted AAA credit rating, which it held since 1949. Specifically the rating agency said that: “credit measures, including free operating cash flow (FOCF) to debt and discretionary cash flow (DCF) to debt, will remain below [its] expectations for the ‘AAA’ rating through 2018.”
While Exxon’s current credit outlook is stable, nonetheless its ability to preserve its impressive 34-year dividend growth streak could eventually end should oil prices remain low for many years; as they did in the 1990’s. That’s because the company’s free cash flow, while positive, is far below its annual dividend cost.
That means that Exxon is currently funding the dividend, including its annual growth, through a combination of non-core asset sales, and debt.
Should oil prices remain below $60 for the next three to five years, the company might have a hard time increasing its quarterly payout even a token amount, such as $0.01 per quarter, per year.
One final risk worth noting is the likely rising of interest rates in the coming few months.
While the US economy continues to grow at a disappointingly slow pace, nonetheless the Federal Reserve maintains that it is strong enough to continue normalizing (i.e. raising) rates. And according to the CME Group, the financial markets are currently putting the probability of an increase in interest rates by December at 65.1%.
While a single 25 basis point increase isn’t that big a blow to Exxon, despite the monstrously capital intensive nature of its business, keep in mind that the Fed currently expects rates to rise by 2.75% over the next four years.
This would make the cost of rolling over its nearly $30 billion debt load much higher, and make securing the dividend, in the event that oil prices remain low for several more years, more costly, should Exxon’s free cash flow fail to rise high enough to cover its payout.
In addition, higher US interest rates will also likely cause the dollar to rise, meaning that oil prices, which are priced in dollars, could come under additional pressure. As would Exxon’s foreign sales and profits, which are collected in foreign currency, and then converted to US dollars for accounting, buyback, and dividend purposes.
Of course, no one has a crystal ball when it comes to forecasting macro conditions. The Fed has been wrong for years regarding the pace and timing of interest rate increases and economic growth. Investors holding Exxon should remain aware that the company remains reasonably safe today but ultimately needs oil prices to rise and favorable credit market conditions.
Dividend Safety Analysis: ExxonMobil
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Exxon’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.
Exxon’s Dividend Safety Score is 52, suggesting that the company’s dividend is reasonably secure and about as safe as the average dividend stock in the market.
This is due to several protective factors. The first is the company’s massively integrated and efficiently run assets, which benefit from such economies of scale that Exxon is able to generate billions of dollars in profits while rivals such as Chevron (CVX) report billions in losses.
In fact, Exxon’s operations are so efficient that over the past 12 months it was able to generate $1.5 billion in free cash flow, or FCF, which is an impressive feat indeed given that it includes $21.4 billion in maintenance, and growth capital expenditures.
And as more of Exxon’s projects come online, resulting in slow but steady production increases over the coming years, its FCF should rise, making the continued maintenance and growth of its dividend a smaller burden on the balance sheet.
Speaking of balance sheet, you’ll note that while Exxon has a lot of absolute debt, its interest coverage ratio of 44.1 means that the company has no problem servicing its liabilities. That’s largely thanks to having an incredibly low cost of debt, courtesy of having the strongest, least leveraged, balance sheet of all the integrated oil majors.
As seen below, Exxon’s low leverage ratio and strong capitalization position it well to continue tapping credit markets at favorable rates. The company should have no problem continuing to issue debt to pay dividends until energy markets recover.
Investors can also take comfort in management’s comments about prioritizing the dividend:
“The dividend is a high priority because it’s part of why we are important to long-term shareholders…We run the business for people that are going to own these shares a very long time, that we hope the shares are in the trust that they leave their children and grandchildren. Whenever we run into challenges and I have to think about how am I going to pay the dividend, I think about those people. And so we are going to pay that dividend. That’s why we are important to people. We will borrow to invest. These projects have returns that are multiples over our borrowing costs.”
Source: ExxonMobil Analyst Day
Importantly, Exxon expects to achieve cash flow neutrality by next year with oil between $40 and $80 per barrel. Low financial leverage and a strong credit rating provide Exxon with the capacity to continue paying dividends and investing in profitable projects as well. Here is another comment from management at the firm’s analyst day:
“If we need to borrow to invest, we’ll do that, because if I’m borrowing money at rates that we got yesterday, and if I can’t generate a return multiples of that, then somehow I have messed this thing up.”
Overall, Exxon’s current earnings and free cash flow are clearly not enough to support the dividend. However, the company can continue pulling several levers (e.g. non-core asset sales; cost reductions; debt issuance; production growth) for at least several years to continue paying dividends until the commodity environment has improved. Investors should continue to monitor Exxon’s most important financial ratios.
Dividend Growth Analysis
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Exxon’s Dividend Growth Score is an 8, owing to the current low oil & gas prices, and the difficulty this puts on the company’s ability to maintain the current dividend, much less grow it.
Then again, Exxon’s dividend history can be traced back more than 100 years ago to 1911. The company is a dividend aristocrat that has raised its dividend for 33 consecutive years through the end of 2015, recording 6.4% average annual dividend growth over that time period. You can see a list of all dividend aristocrats here.
While many other oil companies have either maintained or reduced their dividends, Exxon raised its quarterly payout by 6.7% in 2015 and 2.7% earlier this year. The latest payout raise marks the company’s 34th consecutive annual dividend increase.
What makes this dividend aristocrat even more impressive is that there were no less than four major oil crashes during that time, including the current one.
That being said, as you can see below, analysts are not expecting much in the way of payout growth over the next three years. That’s because, as the oil crash drags on longer than many thought possible, investors need to come to grips with the fact that Exxon’s dividend destiny isn’t entirely in management’s hands.
|Company||Yield||TTM FCF Payout Ratio||Projected 3 Year Dividend Growth||Projected 3 Year Total Return|
Sources: Yahoo Finance, Fastgraphs, Multpl.com, Factset Research, Moneychimp.com
In other words, Exxon investors can likely expect at least a token, $0.01/quarter increase in 2017, 2018, and 2019, even if oil prices remain at today’s low levels. This type of dividend increase would only add $166 million, $332 million, and $498 million to the dividend’s annual cost over the next three years, respectively.
However, predicting if and when the company can return to its historic 7% payout growth rate will depend entirely on how long, and strongly, oil & gas prices recover; something that no one has ever been able to do, and is likely impossible.
That being said, thanks to incredibly efficient operations, a world class management team, and a fortress-like balance sheet, Exxon’s long-term dividend growth rate could eventually return to around 6% to 7% whenever energy prices inevitably rise.
Two key facts support this forecast. First, ExxonMobil currently has numerous projects it is investing its much reduced capital expenditure budget on that will soon come online and help to boost cash flow in the coming years.
In fact, in 2016 and 2017, despite massively cutting spending, and costs, Exxon has 10 major projects scheduled to come online.
The goal of these projects is to boost total production to as much as 4.4 million barrels per day by 2020. However, more important than a slight increase in production is the company’s increasing focus on liquid production over gas.
That’s because the fracking revolution, when combined with the massive Utica and Marcellus shale gas formations of Ohio, and Pennsylvania, have resulted in natural gas prices crashing to their lowest price in half a decade.
As seen below, demand for natural gas is projected to grow nearly twice as fast as demand for oil on an annual basis over the next 25 years.
The increased production of higher-margin liquids, when combined with the fact that the world will still likely be dependent on oil and gas for several more decades, means that Exxon’s future profits and free cash flow are likely to eventually climb to all new record levels.
Which will provide this very shareholder friendly management team with plenty of resources to keep rewarding dividend lovers with many more decades of strong, secure, and steady payout growth.
If you only look at Exxon’s P/E ratio, the stock might appear currently overvalued. However, remember that this is a highly cyclical industry, and during a downturn the P/E ratio tends to soar to high levels as earnings decline.
However, analysts are expecting things to improve in the next few years, thanks to the company’s ongoing cost cutting measures, and the expected increase in production, and thus cash flow, as new projects come online.
|Time Period||Earnings per Share||P/E Ratio|
|Trailing 12 Months||$2.52||34.4|
A different way of looking at the current valuation is to compare the current dividend yield of 3.4% to its five year historical average of 2.8%. From that perspective this appears to be a reasonable time to own Exxon, given that it’s likely near the low point in its business cycle.
From a total return perspective, Exxon’s current dividend yield of 3.4% combines with its potential long-term earnings growth rate of 5-7% to equal annual return expectations of around 8-10% over the long run.
Growing production at some of Exxon’s major project sites is supportive of low-single digit production growth over the coming years, and the company’s downstream / chemical businesses should also continue growing. However, the price of oil will be the big wild card determining overall profit growth.
While no one knows exactly when oil prices will rise, there is a well-known saying in the oil industry. The cure for low oil prices is low oil prices. Which means that, thanks to over $1 trillion in canceled projects over the last two years, an eventual recovery in energy prices is inevitable.
Exxon will grind on, despite the “oilpocolypse,” just as it has for many decades. And thanks to its best in class, conservative, and experienced management team, this dividend aristocrat’s impressive dividend growth streak should survive the oil crash as it has so many other industry downturns.
While ExxonMobil doesn’t necessarily look like a bargain at today’s price if oil remains low, the company remains a fundamentally safe bet for long-term dividend investors looking for energy exposure in a diversified income portfolio. Compared to other oil majors, Exxon is by far the best bet for safe income. While I am being very careful with our exposure to energy markets in our Conservative Retirees dividend portfolio, I will continue to hold Exxon.