An Analyst’s Perspective: Do Low Oil Prices Put Dividends in Jeopardy? | American Funds

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Investment Insights

January 2015

An Analyst’s Perspective: Do Low Oil Prices Put Dividends in Jeopardy?

Frank Hu
Frank C. Hu Equity Investment Analyst Los Angeles office 27 years of experience (as of 12/31/15)
Market declines may provide some attractive entry points for investors.

Oil Companies Have Been a Healthy Source of Dividends Globally

In 2014, the oil industry was the second-largest payer of dividends after financials, contributing 13% of the dividends paid by companies in the MSCI All Country World Index. Royal Dutch Shell and Exxon Mobil were among the largest dividend payers of all index constituents.

Source: FactSet, as of December 31, 2014.

* Figures may not total 100% due to rounding. 

Over the last few years, large oil and gas companies have been among the biggest payers of dividends. Clearly the decline in oil prices is concerning because in most cases, it means that dividends cannot be fully funded from free cash flow. But I believe that, for the large integrated oil companies, the oil price would have to fall a lot further to call into question their ability to pay and increase their dividends.

Although many of the large integrated oil companies have struggled with capital discipline and have seen margins shrink in recent years, they have maintained relatively healthy, underleveraged balance sheets. So while in the short term most of the major oil companies lack the flexibility to cut capital expenditures in order to protect their dividend payments, the good news is that, unlike some other companies, they do not need to resort to these measures.

If you look at the liquidity and debt capacity available to fund dividends and keep production flat at various oil prices, most of the big companies have enough cash and credit available to fund these payments even if low prices persist for a number of years. Additionally, the flexibility of these companies to cut capital expenditures increases over time, so even if oil prices remain lower for longer, it is my belief that the dividends would be safe.

Finally, it is important to note that, for many energy companies, paying a dividend has been a high priority for management. Chevron, for example, has increased its dividend every year for more than 25 years. Even when oil was $30 a barrel and the financial system was frozen in 2008, Chevron still increased its dividend. Royal Dutch Shell has a similar story, and I do not expect this to change. Many of these companies offer yields that are double that of the broad market and dividend growth rates that are likely to be healthy regardless of commodity prices. Therefore, current weakness may represent a good opportunity for income–oriented investors to add to these investments.

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Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.