- Exxon Mobil and Chevron have recently reported one of their worst quarterly results ever, thanks to weak oil prices.
- The two, however, have stuck with their dividend policies, and the decision actually makes sense considering the improvement in the outlook for oil.
- But remember, we are not out of the woods yet.
Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), the two leading US oil companies, have recently reported one of their worst quarterly results in years. Both have seen their revenues, earnings and cash flows plunge as oil prices dipped to their lowest levels in more than 10 years. The two companies, however, have moved to allay investor concerns regarding dividends. Are dividends really safe? For this, we’ll need to dig a little deeper.
To say Exxon Mobil’s latest quarterly results were bad would be an understatement. The company reported 28% decline in revenues to $48.71 billion while earnings slumped 63% to $1.81 billion. That’s the lowest quarterly profit since the 1999 merger between Exxon and Mobil which gave birth to the oil giant. The company’s upstream or exploration and production business, which managed to remain profitable throughout the downturn, swung to a rare loss of $76 million from a profit of $2.86 billion a year earlier.
Chevron, on the other hand, wasn’t profitable at all. The company’s earnings slipped from a profit of $2.6 billion a year to a loss of $725 million as its upstream business reported a massive loss of $1.46 billion compared to a profit of $1.56 billion seen last year. That was the first Q1 loss for Chevron in two-and-a-half decades.
Not surprisingly, the biggest culprit was oil prices. Prices of both international Brent and US WTI crude reached more than decade lows in the first two months of this year. Consequently, Brent and WTI averaged less than $34 a barrel in the first quarter, according to Chevron, down from almost $54 for Brent and $48.60 for WTI in the same period last year. On top of this, the oil majors also witnessed weak refining margins, due in large part to weak demand for refined products, which hurt the profits of their downstream businesses.
The tough business environment has already forced a number of major oil producers, such as ConocoPhillips (NYSE:COP), to slash dividends. But Exxon Mobil and Chevron have stuck with their payout policies. In fact, Exxon Mobil has recently increased the dividend by 3%, just a day after the oil producer lost its coveted AAA credit rating from the S&P while reminding investors that it has been consistently growing dividends for the last 34 years. The stock currently yields 3.4%.
Chevron, on the other hand, did not increase dividends, but during the most recent conference call, the company’s management repeatedly said that “sustaining and growing the dividend is still the first priority from a cash use standpoint.” Chevron’s CFO Patricia Yarrington also talked about the company’s “28-year record of consecutive annual per share payment increases” while discussing the latest quarterly results. Chevron offers a yield of 4.2%.
While looking in the rear-view mirror, with the dismal first quarter performance, it appears that Exxon Mobil and Chevron may find it difficult to sustain or grow dividends in the future. However, the outlook on oil has improved substantially since the first three months of this year. The Brent and WTI oil prices are currently hovering in the mid-$40s – that shows a gain of more than 30% from the first quarter average and an increase of more than 60% from first quarter’s bottom of under $27 a barrel. And these gains are based in part on the improvement in demand-supply fundamentals, which means that they might be sustainable.
Oil demand isn’t growing as fast as we would like, but a growth rate of 1.2 million barrels a day for the current year, according to the International Energy Agency’s latest estimate, is still higher than the average of around 1 million barrels a day seen during the ten years ending 2013. On the supply side, the global oil flows are positioned to decline this year as compared to last year. The US production peaked last year and recently went below 9 million barrels a day. Saudi Arabia’s oil production also peaked last year at a little less than 10.6 million barrels a day in July. Russia, the world’s leading crude producer, has been holding its output steady at around 10.9 million barrels a day since January. Iran is the only nation that is meaningfully growing oil production, which could partly make up for the decline in global oil output.
If oil finds support at mid-$40s and gradually moves to $50s by the end of this year, then that is going to lift Exxon Mobil and Chevron’s cash flows. Remember, Exxon Mobil and Chevron do not hedge as a rule, so a strengthening crude oil price environment can immediately increase their cash flows. In this scenario, the first quarter could turn out to be the bottom of this oil cycle. However, astute investors should be prepared for other scenarios as well.
While it appears that oil prices are positioned to gradually climb to the $50s, there are still a number of known unknowns that could derail this rally. Firstly, there are record quantities of crude stored all over the world, including at the US storage hub at Cushing, Oklahoma where stockpiles are at their highest level in more than eight decades. Nobody is sure exactly how the storage overhang is going to play out. Secondly, it remains unclear whether Iran can completely offset the impact of decline in production from other regions, which could result in an increase in the total global output. That could exacerbate the supply glut. Thirdly, US producers could ramp up drilling activity in response to higher oil prices, resulting in an improvement in US crude output. These factors could potentially wipe out crude's recent gains, pushing oil back into the $30s. And that’s going to be bad news for Exxon Mobil and Chevron.
Remember, so far, in the ongoing downturn, both companies have failed to fully find their capital expenditure and dividends from internally generating cash flows. In the previous quarter, Chevron generated just $1.1 billion as operating cash flows while it spent $5.6 billion in capital expenditure (cash capex) and $2 billion on dividends. Similarly, Exxon Mobil reported $4.8 billion of operating cash flows, but spent $5.1 billion as capital expenditure and $3.1 billion in dividends. Clearly, both witnessed a massive cash flow shortfall of billions of dollars.
If oil prices fall back again, then Exxon Mobil and Chevron will continue to report significant cash flow deficits. Exxon Mobil, for instance, plans to spend $23.5 billion on capital expenditure this year and, on an annualized basis, could spend $12.4 billion on dividends this year. This translates into cash outflows of $35.9 billion. On the other hand, in a weak oil price environment, the company’s cash flow from operations will likely decline from last year’s $30.3 billion. If they drop by, say 40%, then the company will fund 77% of its capital expenditure from internally generated cash flows while the remaining 23% and all of the dividends will be powered by asset sales and borrowings. The situation looks worse for Chevron. If its cash flows also drop by 40% this year, then it will be able to fund less than half of its capital expenditure, even if it spends at the low end of its guidance of between $25 billion and $28 billion.
No company can continue rewarding shareholders with dividends amid mounting cash flow deficits. Eventually, Exxon Mobil and Chevron will be forced to reduce their cash outflows by cutting back on capital spending, payouts, or both.
Exxon Mobil and Chevron have recently reported one of their worst quarterly results, thanks in large part to weakness in oil prices. The two however, have stuck with their payout policies, with Exxon Mobil growing dividends while Chevron promising that dividend remains a top priority. With the improvement in oil outlook, powered mainly by demand-supply fundamentals, it appears that Exxon Mobil and Chevron are positioned to continue rewarding shareholders with dividends. But remember, oil could fall back to $30s, and if it does, the two oil majors will face mounting cash flow deficits. Without any support from oil prices, the two could be forced to change dividend policies. In short, although the outlook appears to have improved, we are not out of the woods yet. Therefore, investors should stay cautious.