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5 oil stocks for a dividend bonus
Companies like Exxon Mobil traditionally pay out little of their profit as dividends. But that's changing fast. Here are 5 oil stocks that could be great future dividend plays.
By Jim Jubak
When it comes to dividends, most oil companies are tightwads. Exxon Mobil (XOM, news, msgs), for example, made $7.8 billion in net income in the first quarter of 2005. That was up $2.4 billion from the first quarter of 2004.
And yet the company's stock yields just 1.9%. It pays out a miserly 27% of profits to shareholders as dividends.
And Exxon Mobil isn't by any means the stingiest of the lot. Although BP (BP, news, msgs) yields 3.4% and Shell Transport & Trading (SC, news, msgs) a very respectable 5.5%, many oil stocks pay less than 1% or no dividend at all. For instance, Apache (APA, news, msgs) shows a yield of just 0.6%, Anadarko Petroleum (APC, news, msgs) and Burlington Resources (BR, news, msgs) just 0.7% and Pogo Producing (PPP, news, msgs) just 0.6%. St. Mary Land and Exploration (SM, news, msgs) pays nothing.
That should change in the next couple of years. Growth in oil-company dividends is on a long-term and very steep upward trend. And for investors who will retire five to 10 years from now, oil stocks are the best dividend bet in the market. If you know what to look for in an oil-stock dividend play, that is. By the end of this column, I'll have given you five oil stocks to check out as 10-year income plays.
Bigger dividends ahead
Oil companies are tight with dividends for good reason. The oil industry is notoriously cyclical, and smart companies save during boom times so that they can survive -- and acquire their less-foresighted competitors -- in the bust times. The more conservative oil company CEOs still aren't convinced that oil will stay above $40 a barrel in the long run. They're hesitant to raise their company's dividend because they think of a dividend as a long-term commitment to shareholders. They certainly don't want to have to cut that payout when the boom is over. They'd much rather put some extra cash to work buying back company shares.
You don't have to be a believer in $100-a-barrel oil to see why that is about to change. As oil becomes more expensive and harder to find and produce, it becomes more difficult for many oil-company CEOs to justify reinvesting the cash thrown off by the current business.
Look at it this way. Whether you run a supermajor like Exxon Mobil or a small domestic producer such as St. Mary Land & Exploration, you are in the business of selling off oil and gas acquired years ago when oil prices were much lower. Because the cost of acquiring those deposits was so low -- and current prices are so high -- your company is reaping a huge return on its initial capital investment. Exxon Mobil, for example, shows a return on invested capital of 23.7% for the last 12 months. That puts its return well ahead of such icons as Wal-Mart Stores (WMT, news, msgs) at 14.1%, Starbucks (SBUX, news, msgs) at 15.1%, Procter & Gamble (PG, news, msgs) at 20.9% and Microsoft (MSFT, news, msgs), the owner of this site, at 21.2%. Exxon Mobil's return on invested capital is extraordinary for an industrial company with huge investments in capital equipment and infrastructure.
Related news and commentary on MSN Money
There's no way that any new deal, even a great deal like Occidental Petroleum's (OXY, news, msgs) auction win in Libya, at current asset prices and with current production costs can match the return on capital that oil companies are reaping now from prior investment.
Oil executives have a choice: They can invest in new exploration and production and acquire proven reserves and accept lower returns on capital and eventually lower multiples that investors are willing to pay for oil stocks. Or they can curtail investing in new reserves and instead return that money to shareholders in the form of dividends.
That may seem unthinkable, since not investing in new reserves will ultimately lead to the liquidation of any oil-and-gas company. And it may indeed be unthinkable to some oil company executives who can't imagine putting shareholder interests ahead of their own jobs and the continued existence of the company.
Got 5 years? Here's how to generate income
But the road to self-liquidation isn't as seldom taken as investors imagine. And as some savvy income investors know, royalty trusts, which pay out almost all of the income from the production of oil and gas to shareholders as these companies liquidate their reserves, offer exceptionally high yields, even after very strong recent appreciation. (A company can spin off part or all of its assets into a royalty trust. Production on the trust is farmed out to another oil or gas company.)
For example, the BP Prudhoe Bay Royalty Trust (BPT, news, msgs), yields 9.9%, the Permian Basin Royalty Trust (PBT, news, msgs) yields 7.1%, the San Juan Basin Royalty Trust (SJT, news, msgs) yields 7% and the Santa Fe Energy Trust (SFF, news, msgs) yields 10.6%. Watch out for volatility in the share prices of these trusts. Since their entire income depends on the price of oil and gas, they can rise and fall sharply with the commodity. Conservative income investors should wait until they feel that the current correction in energy prices and energy stocks is close to an end before buying shares.
But the most interesting income play in oil and gas, to my mind, lies in between the supermajors, who aren't likely to contemplate liquidation (and who own vast refining and retailing networks that don't fit the royalty trust model at all), and the existing royalty trusts.
Investors who have half a decade or more before they need to generate income for retirement can put that time to work to generate yields that are certainly above what 10-year Treasury notes are paying now and probably above what 10-year notes will pay five to 10 years from now. (And, of course, these investors won't be giving up all gains in the interim, since they'll participate in whatever price gains energy stocks deliver.)
How do you pull off this trick? By looking for oil and gas stocks that are paying relatively modest yields now but that are likely to raise dividends strongly as their oil and gas assets continue to bring in rivers of cash.
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