Safety and Income in Really Big Oil
Conservative investors are searching for safe havens for their money, and many were burned recently by some of the royalty trusts that were using very optimistic assumptions about future payouts. Those entities’ high yields came with a level of risk that was not appreciated by many investors. Some investors later told me they couldn’t afford a decline of 15 percent, but the losses were even more severe in many cases. (As an aside, if you can’t stomach a loss of that magnitude it’s best to stay away from equities, because even the best ones regularly suffer such declines.)So is there any safe place in the energy sector for the conservative, income-oriented investor? There certainly is, and it’s in the shares of the large, integrated oil and gas companies, which are now paying relatively attractive yields backed by dependable cash flows. Today I’ll take a look at six such heavyweights.
Headquartered in Irving, Texas, ExxonMobil is a fully integrated oil and gas company with production and refining facilities, and a commodity petrochemicals business. When I worked in the oil industry, we knew Exxon as an oil company that knew it was an oil company. The people in charge weren’t apologizing for that, and they weren’t trying to be anything else.
ExxonMobil’s success is the product of a strong management team and a disciplined approach. This is reflected in a Return on Capital Employed (ROCE) of 25 percent, the best among its peer group. ExxonMobil earned $45 billion in 2012, and funded almost $40 billion in capital spending. At the same time, the company paid out $30 billion in dividends and continued a share buyback program that reduced the number of outstanding shares by nearly 5 percent in 2012.
XOM’s reserve replacement ratio (RRR) — the volume oil and gas added to reserves divided by the volume produced during the year — was 115 percent in 2012. This marked the 19th consecutive increase in reserves over the previous year. This is a remarkable achievement, one matched by few if any other integrated oil majors.
ExxonMobil’s dividend yield currently stands at 2.6 percent, which is an increase of 59 percent over the past five years. While it is true that this falls short of the payouts from many of the royalty trusts, investors can sleep easier at night knowing that XOM’s Beta is only 0.49, meaning its stock is only half as volatile as the market.
Exxon Mobil’s market capitalization presently stands at $400 billion. One of the knocks on the stock is that it has made little headway over the past five years, after a big run over the prior five-year period. This is widely attributed to ExxonMobil’s ill-timed $41 billion buyout of natural gas producer XTO Energy in 2009. This made Exxon the largest natural gas producer in the country just before natural gas prices began a long decline. Over the last five years, XOM shares have actually declined 5.5 percent, but are up 154 percent over the latest 10-year period. XOM stands to benefit from the recent recovery in natural gas prices.
Institutional investors hold 51 percent of XOM shares, which presently trade at a trailing price to earnings (PE) ratio of 9.2. Debt is very low at 3.5 percent of current assets, and the profit margin of 10.2 percent leads most peers. But one company has done just a bit better that that.
While ExxonMobil may be considered the pace-setter in the integrated oil and gas business, Conservative Portfolio holding Chevron (NYSE: CVX) has outperformed its larger rival over the past five years. CVX pays a slightly higher dividend than XOM (3.1 percent versus 2.6 percent), and its share price has appreciated 26 percent over the past five years. (Keep in mind that this includes the oil price crash of 2008. Over the last 10 years, CVX is up an impressive 267 percent.)
Chevron’s market cap of $228 billion is substantially behind that of XOM, but that was still good enough for third place on last year’s Fortune 500 list, with Walmart (NYSE: WMT) sandwiched between them. Chevron’s 2012 profit margin was slightly ahead of Exxon’s at 10.9 percent. The higher profit margin — as well as Exxon’s lagging stock performance relative to Chevron — is largely a reflection of the fact that natural gas is a larger component of Exxon’s business, so that it was harder hit by last year’s price crash.
Chevron lags Exxon in ROCE (18.7 percent versus 25.4 percent), and has a slightly higher level of debt to assets at 5.4 percent. (Though it also has more cash than debt.) Chevron’s reserve replacement ratio of 112 percent was also slightly behind that of Exxon’s. Like ExxonMobil, Chevron spent $5 billion in 2012 buying back shares of the company. Chevron’s Beta of 0.77 is higher than Exxon’s, but still very appealing for conservative investors. During the oil price plunge in the second half of 2008, Chevron’s share price only fell 10 percent (vs. 18 percent for XOM).
The biggest concern for many investors is a $19 billion judgement against Chevron for environmental damages in Ecuador. It concerns operations that Texaco had in Ecuador from the 1960s until about 1990. Chevron acquired Texaco in 2001, and after years of legal battles lost a lawsuit brought by plaintiffs in Ecuador.
Chevron claims that this lawsuit is fraudulent, because the Ecuadoran government had already certified that the proper level of remediation had been performed. Further, Chevron has brought evidence of bribery and payoffs that it says should be reason to overturn the verdict.
Most industry observers believe that Chevron will not be forced to pay this judgment. However, plaintiffs have sought to enforce the judgment and seize Chevron’s assets in sympathetic countries. As long as this drama continues to play out, Chevron’s shares will be weighed down slightly.Nevertheless, Chevron remains our favorite stock among the major integrated oil companies, and we’re raising our buy below target accordingly. Continue to accumulate shares on any sign of weakness. Buy Chevron below $125.
Royal Dutch Shell
Trailing slightly behind Chevron in terms of market cap is the first foreign-based major integrated on the list, Dutch-based Royal Dutch Shell (NYSE: RDS.A). In 2012 Shell posted nearly identical revenue as ExxonMobil, but Shell’s 5.75 percent profit margin was significantly lower than Exxon’s or Chevron’s. Shell’s dividend yield, however, is more attractive at 5.3 percent.
Shell’s 2012 ROCE was lower still than Chevron’s at 12.7 percent, and in notable contrast to ExxonMobil and Chevron Shell’s reserves replacement ratio was only 44 percent. Shell has said it expects the reserve replacement ratio will remain below 100 percent for at least the next three years, despite plans for $33 billion in capital spending next year.
Many investors lost trust in Shell in 2004 when the company was forced to admit that it had overstated its oil and gas reserves by 41 percent. This occurred because Shell was less cautious than peers about placing speculative reserves into the proved reserves category. Since that restatement of reserves, Shell shares have significantly underperformed Exxon and Chevron.
Shell’s also recently suffered a public relations hit as a result of its Arctic drilling campaign. Over the past few years Shell has spent nearly $5 billion preparing to drill for oil off Alaska’s Arctic coast. After a series of delays and mishaps, its drilling rig, the Kulluk, ran aground and had to be sent to Asia for extensive repairs. The Department of the Interior released a report that was highly critical of Shell’s operational and safety procedures and said Shell would have to make significant changes before being allowed to drill further in the Alaskan Arctic.Thus, Shell’s higher dividend comes with the risk that it will continue to underperform the market leaders. Investors in Shell will also likely face higher volatility, as Shell’s Beta is almost equivalent to that of the market at 0.95.
BPAt one time, UK-based BP (NYSE: BP) looked to be on its way to contending for the title of world’s largest integrated oil and gas company. But unlike ExxonMobil, BP suffered an identity crisis along the way and spent many years working to convince the world that its environmental credentials were a step above those of its industry. Thus, “British Petroleum” was rebranded as the more environmentally responsible “Beyond Petroleum.”
But BP also didn’t have the same sort of safety culture as some of its competitors. When I worked for ConocoPhillips in Scotland, BP had a major presence there. I got to see some of BP’s operations up close and at times was puzzled by some of the company’s decisions with respect to safety.In 2005, an accident at BP’s Texas City refinery killed 15 people. A subsequent investigation headed by Former Secretary of State James A. Baker was extremely critical of BP’s safety procedures, and BP ultimately pleaded guilty to a federal felony charge and was hit with more than $50 million in fines. The “Beyond Petroleum” image that BP had begun to craft in 2000 took a serious hit.
Fast forward to the disastrous Deepwater Horizon oil spill in 2010, in which the BP-operated rig managed to spill nearly 5 million barrels of oil over the course of several months into the Gulf of Mexico, and the image of BP that former Chief Executive John Browne had worked so hard to craft was in tatters.I wrote several articles about BP at the time, and the bottom-line message was to avoid buying into the company on weakness. Not only was the liability potentially going to be the worst any oil company has faced in history, it was uncertain how badly the BP brand would be damaged. In the three years since that accident took place, shares of BP have fallen 30 percent. By comparison, over the same period the share price of Chevron has increased 48 percent.
BP does pay an attractive dividend of 5 percent, but the 2010 disaster continues to weigh on the company’s fundamentals. Despite the steep correction in the share price, BP still trades at a trailing PE of 11.5, a premium to stronger peers. The profit margin is a paltry 3 percent, and the Beta is above the market average at 1.2.BP is undervalued by some metrics and will likely bounce back. There is going to be some value for those who are willing to take the risk. But at present I would continue to steer clear of this company.
TotalThere are two foreign-based companies that we do like. The first is France’s Total (NYSE: TOT). A current Best Buy in our Conservative Portfolio, Total’s dividend yield is a hefty 6.2 percent.
Total’s market cap is $108 billion, and most of its business is conducted in Europe. The profit margin of 6 percent is better than that of Shell or BP, but Total’s 19.4 percent debt-to-asset ratio is significantly higher than that of any of the companies previously discussed.Total’s ROCE is a respectable 16 percent, and the Beta of Total’s stock is 0.99. Total’s share price has lagged its American peers over the past year, which is partly due to the European recession, but also because of additional taxes imposed on Total by France. Total’s trailing P/E of 7.8 is about the same as Shell’s, and Total’s 93% reserve replacement ratio for 2012 was better.
Total’s key financial metrics lag those of its American counterparts ExxonMobil and Chevron, but for those looking for a high yield from a diversified resource base, it is a solid choice. Buy Total up to $57.But another European company offers an attractive dividend and a compelling growth story.
EniLike Total, Italian super-major Eni (NYSE: E) is a Best Buy in our Conservative Portfolio. And like Total, Eni carries an attractive dividend yield of 6 percent.
Other financial metrics are also similar to Total’s. Eni operates in the same geographic region, with 70 percent of its revenue coming from Europe. Eni’s profit margin of 3.8 percent lags that of Total, as does its 11.1 percent ROCE. However, Eni’s share price has outperformed Total’s over the past 12 months. That’s reflected in Eni’s trailing P/E ratio, which at 15.2 is almost double that of Total.But Eni led all its European rivals with a 2012 reserve replacement ratio of 147 percent, aided by a significant natural gas discovery off the coast of Mozambique. It ended the year with reserves equivalent to 7.2 billion barrels of oil (bboe), an eight-year high. In 2012 Eni discovered a record 3.6 bboe of hydrocarbons.
These new discoveries should provide Eni with significant growth potential in the coming years, and Eni has a strong record of increasing dividends. Buy Eni up to $52.Key Peformance Indicators for the Big Six