- Exxon stock has withstood the carnage taking place in the oil industry till now.
- But with oil prices likely to remain depressed for a long time, even Exxon's financials will be under pressure.
- The company needs to re-think its capital return policy in light of continuously deteriorating financials.
Past couple of years has seen absolute carnage in the oil and gas sector. The crude oil price declined from above $100 to $28 before recovering to the current price of $42. The drastic decline in the oil prices has left the sector gasping for growth. Most of the oil companies are in red and some even had to shut down. In all this carnage Exxon Mobil (NYSE:XOM) managed to stay relatively safe. It's solid balance sheet, strong cash flows and strong production has helped it fight the downturn till now. Exxon stock has returned 13% in last one year while US Oil ETF (NYSEMKT:USO) has given a negative return of 38% in the same period. And in the last two years, Exxon stock declined by 12% while USO has tanked by a massive 75%.
This remarkable resilience of Exxon in the face of the massive decline in oil prices and the slowing economy has made it a "safe haven" for investors in the oil segment. It is this “safe haven” and the “dividend aristocrat” status that has attracted many income investors to this stock. Exxon has raised its dividend every year since last 34 years, no mean feat by any standards. And there is a belief that Exxon will continue to hike the dividend in the coming years too.
But how long can Exxon Mobil keep its dividend spigot open? While in earlier years Exxon managed to pay the dividend by growing its cash flow and revenues, the last couple of years has been a different ball game altogether. The declining oil prices have taken a toll on Exxon’s financials.
Declining Profits Make Dividend Growth Unsustainable
In the latest quarter, Exxon reported a 22% decline in revenues while net profit declined by almost 59% on YoY basis to $1.7 billion from $4.1 billion. The even bigger worry is that the net income figure was lower than the last quarter, clearly indicating that Exxon’s profits have not found a bottom. Also, the oil prices in the second quarter were higher than the first quarter, with prices recovering around 65% from their lows of $28 in January.
The massive decline in profits has forced Exxon to take extraordinary measures to continue the dividend payments. In Q2 Exxon earned $1.7 billion in profits while it distributed $3.2 billion in dividends, a dividend pay out ratio of more than 170%. On the cash flow front, Exxon generated $4.5 billion from operations and $1 billion from asset sales. On the other hand, Exxon spent $5.2 billion on asset purchase, leaving it with almost nothing to foot the bill for its dividend payment of $3.2 billion. Such a large cash flow mismatch will definitely lead to increase in Exxon's debt burden in the long run. Clearly borrowing for the sake of paying dividends is not sustainable.
Capex Reduction Will Harm Long Term Growth
To keep its cash flows mismatch from going out of hand, XOM has been relentlessly pruning its capital expenditure in the last several quarters. For the first six months of the current fiscal, Exxon's capital expenditure (including asset sales) stood at $8.87 billion which is 36% less than what it had spent last year during the same period. Exxon is likely to keep a check on its capital expenditure in future quarters also. This relentless cutting in capex is detrimental for Exxon's long-term growth. If oil prices are likely to remain low in coming quarters then Exxon needs to take a call on whether to continue its dividend hike by borrowing from the market and cutting its capex or take a breather from the dividend hike.
Of course, cutting the dividend or even a halt in the continuous dividend increases is bound to have a disastrous impact on the stock price (a risk which income investors should definitely consider), considering the premium attached to its dividend aristocrat status. But Exxon needs to balance out the long-term impact of a constraint on capital budget and impact of halting its dividend growth. The way I see it few more quarters of low oil prices should push Exxon to pause the dividend hike if not cutting the dividends.
A lot will depend on how oil prices will behave in the coming future. While the last couple of years suggest that it will be foolhardy to forecast future oil prices, the slow down in economic growth and shale oil producers will keep the oil prices in check. Exxon can't go on hiking its dividend while its cash flows and net income continue to decline. There is a real possibility of Exxon not raising its dividend or even affecting a cut in its dividend payout, and should this happen the stock will tank. Income investors must also consider the possibility of a dividend cut as a potential risk.