Record Dividends are Energizing These Oil Majors

Dividend Investing, Energy Investing, Oil

It’s a good time to be an investor that focuses on dividends.

According to the asset management company Janus Henderson, investors enjoyed a record haul for global dividends in the third quarter. Total global payouts hit $415.9 billion in the third quarter of 2022.

The seven percent rise from the same period a year ago was fueled by soaring payouts from the energy sector. Without the nearly $20 billion contribution from the oil and gas sector, the global total would have been flat year on year, according to the Janus Henderson Global Dividend index.

“The energy crisis drove a large rise in dividends in the third quarter, as oil companies distributed record profits to shareholders,” the asset manager said in its latest dividend report.

The increase was driven by special dividends – one-time payments which are often larger than normal payouts. And the trend was global, with the biggest dividend jumps coming from energy companies in Brazil, Hong Kong, the U.S. and Canada. Country-wise, the actual largest contributors to dividend growth were the U.S., Hong Kong and Taiwan.

The bumper crop of large dividend payments in the third quarter drove up Janus Henderson’s headline dividend expectations for 2022 by $30 billion to $1.56 trillion, up 8.3% year on year.

2023 Outlook

What’s the outlook for dividends in 2023?

Obviously, the outlook will be dependent on what the global economy does. If we do go into a global recession, companies’ earnings will be impacted. However, the good news is that dividends tend to be more resilient. Generally companies don’t want to cut or, especially, eliminate them.

And, as a contrarian investor, I would prefer to look for dividends in the sector that Wall Street continues to rate lowly, despite an outstanding 2022 – the energy sector.

As the Janus Henderson survey of global dividends found, this is where the dividend growth was in 2022. I believe 2023 will also be a good year for the energy sector, with dividends staying healthy.

There are many global oil and gas companies to choose from. However, the two U.K.-listed energy majors, Shell (SHEL) and BP (BP), are trading more cheaply than their European and US-listed peers, despite handing back massive amounts of cash to shareholders through buybacks and dividends.

SHEL & BP: Dirt-Cheap

Shell and BP seem to be unloved, high-return investments. Even after the more than 25% share price increases seen so far in 2022, the two oil and gas behemoths remain lowly rated by Wall Street.

Shell and BP sit on EV/EBITDA ratios of 3 times and 2.8 times, respectively. EV/EBITDA is a ratio that compares a company’s Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA). The EV/EBITDA ratio is commonly used as a valuation metric to compare the relative value of different businesses.

The U.S. oil majors Chevron (CVX) and ExxonMobil (XOM) are more highly rated, at 5 times. And while cross-sector comparisons between tangible and intangible assets can be difficult, it’s notable that, even after a year in which commodity stocks have surged while big tech stocks have struggled, even Facebook parent Meta (META) still trades at an EV/EBITDA ratio of 7.8 times.

Meanwhile, the fundamentals of the oil and gas business remain strong.

The upstream divisions at both companies remain the big moneymakers. Let’s look at BP, for example.

RBC Capital Markets forecasts BP’s oil production and operations division earnings at $25 billion this year, up from just $10.3 billion in 2021. And if higher oil prices alone weren’t enough, refining margins have soared this year as well – BP reported a June quarter refining margin of a whopping $45.50 per barrel, compared with $13.70 a year ago.

Overall, the European oil majors allocated a third less capital expenditure – a drop of around $15 billion – on upstream projects in 2021 than they did in 2019, according to International Energy Agency (IEA) estimates.

Then, with that already in place, Russia’s invasion of Ukraine is still upending global energy markets.

The IEA has made clear the point that exploration spending is still “well below” levels seen in the 2014-15 bear market.

Yes, 2021 saw a strong rebound in oil project approvals. However, national oil companies (mainly in the Mideast) were responsible for more than 75% of the total, according to the IEA.

What’s Next

The end result? Higher oil and gas prices for longer. That’s great news for BP and Shell.

Strong oil and gas prices should continue to provide a tailwind for these companies, and the virtuous circle of higher free cash flow, continued de-leveraging (paying off debt) and multi-decade high shareholder returns should support the investment case for them.

Think about it from a dividend viewpoint.

BP’s stock buybacks will reduce the share count, cut the overall dividend cost and therefore push up the quarterly payout. BP is set to buy back more than $10 billion worth of shares this year, up to 20% of daily volumes.

Shell’s approach is similar.  Shell is repurchasing $21 billion or 12% of its market cap this year. That gives it significant capacity to raise the dividend going forwards without increasing the absolute dividend burden on the company.