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Is Exxon's Dividend Too High To Justify?

The energy sector has emerged as the best performer over the past few weeks, with WTI crude prices climbing to their highest level in nearly eight months thanks to a flurry of potential Covid-19 vaccines

Optimism has returned to the oil markets in a big way. Even conservative BP Plc (NYSE:BP) has backtracked on its earlier projections that we might have passed peak oil, with the company now saying oil demand might not peak till around 2030.

Yet, Big Oil is still far from being out of the woods, with big dividend payers, in particular, remaining in a precarious position.

With WTI trading at ~$45, Raymond James analyst Pavel Molchanov says ExxonMobil (NYSE:XOM) is still not bringing in enough cash to fund its dividend and faces an "unenviable choice" of either selling assets or taking on more leverage to support the dividend.

Last month, Exxon announced that it will keep its dividend at 87 cents per quarter, giving the company a stunningly high payout of 11%. 

However, that yield has now fallen to 8.7% after XOM stock climbed 23% over the past month.

Big Decisions

Exxon is faced with big decisions on dividend tradeoffs. 

The company is still bleeding cash at current oil prices, needing WTI crude price at ~$50/BB to be able to manage its generous payout and also continue with maintenance-level capital spending from operating cash flow. 

Exxon needs ~$8B in debt financing to maintain the current dividend level in 2021. However, Molchanov says that divesting assets at potentially suboptimal valuations is the most probable near-term solution but not sustainable. 

During its latest earnings call, Exxon revealed that it's in advanced talks on several potential divestments. Earlier, the company said it had lined up $15B in potential divestments and is also assessing the sale of North American dry gas assets for a combined carrying value of up to $30B. If successful, the divestments would rank as some of the largest impairments ever in the oil industry.

Related: Climate Targets Could Slash Natural Gas Investment By $1 Trillion

Luckily for Exxon, the company can still borrow at attractive rates. However, it reiterated during the earnings call that it does not plan to raise more debt.

Raymond James analyst Pavel Molchanov told clients in a Friday note, as reported by MarketWatch, that Exxon has three ways to avoid its first dividend interruption in decades in what he called an "unenviable choice". 

  1. Break its pledge to not take on more debt, which Molchanov described as "feasible" but bad for credibility. 
  2. Sell assets for prices shareholders won't appreciate, but which would support dividend payouts--a choice Molchanov described as "most probable" but not sustainable long term. 
  3. Cut dividends, which the analyst described as a "radical approach" that wasn't likely to happen for at least a year.

Either way, Molchanov has a "sell" equivalent rating on Exxon right now. And he's not alone. 

Wall Street Turns Positive on Energy

After souring on the sector for years, Wall Street is increasingly turning positive on energy, with a growing number of analysts expressing optimism that the worst could be in the rearview mirror.

Bank of America is the latest to join the bullish camp and believes the Covid-19 vaccines will help return oil demand to normal levels in a matter of months. 

BofA analyst Doug Leggate has projected that many oil and gas stocks will see significant upside in 2021 if Brent prices are able to rally to $55 per barrel or higher. Brent crude traded at $70 in January before the pandemic caused the biggest demand destruction in history.

BofA has an overweight rating on the energy sector and has advised investors to focus on three types of stocks:

  • Leveraged oil stocks with bullish catalysts ahead e.g., Apache Corp. (NYSE:APA) and Hess Corp. (NYSE:HES)
  • Oil stocks that pay sizable dividends e.g., ExxonMobil, Chevron Corp. (NYSE:CVX) and ConocoPhillips (NYSE:COP)
  • Oil companies with potential to grow their free cash flows through consolidations or other cost reduction measures e.g., Pioneer Natural Resources (NYSEPXD), EOG Resources (NYSE:EOG) and Devon Energy (NYSE:DVN)

The mid-term outlook has improved considerably after news that OPEC and its Russia-led partners are likely to extend oil production cuts for another two to three months in a bid to keep markets tight and encourage further recovery in oil prices.

OPEC is scheduled to meet on Monday to map out its production strategy before meeting with a group of Russia-led producers on Tuesday. OPEC+ appears to have learned its lesson, and members are largely expected to co-operate if the organization agrees to extend production cuts.

By Alex Kimani for Oilprice.com

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