Jubak's Journal Recent articles: • Is there fraud in the house of Saud?, 4/29/2005 • 5 health care havens, 4/27/2005 • From Russia, with love: $60 oil, 4/26/2005 More... | Jubak's Journal 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 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 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 Related news and commentary on MSN Money
There's no way that any new deal, even a great deal like Occidental Petroleum's 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 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. 5 oil stocks to tap Of the majors, ConocoPhillips That's OK when the yield on a 10-year Treasury note is also below 4.2%, but if you expect inflation and a weak dollar to keep pushing up interest rates over the next decade, you'd probably prefer to put your money into something else now and then buy a Treasury at what is likely to be a higher yield a decade from now. But notice what the sharp jump in oil prices has done to the rate of dividend growth at ConocoPhillips. Although the five-year annual average growth is 5.8%, the company increased its dividend by 31.8% in the last year. Plunk that into your calculations, and at that rate of increase, in 10 years an investor is looking at a dividend of $39.23 a share and a 37.2% yield on shares purchased at today's price. (You can download an Excel calculator to take you through these steps for ConocoPhillips here.) Wow! And now back to reality. Of course, that yield is pretty much pure nonsense. The huge dividend increases of the last year are the result of a jump in oil prices from a range in the $20s to today's price near $50 a barrel. If you project that rate of increase -- of oil prices and dividends -- into the future, you get rubbish as a result of your calculations. But I think you can expect that, as a result of higher oil prices caused by a continued squeeze on supplies, dividend growth will be faster in the next 10 years than it has been in the last five. That's especially true since company boards of directors are conservative bodies that raise dividends only when they're convinced that increased profits are an absolutely certain trend. Dividend increases then tend to lag behind earnings increases. So I'd be comfortable estimating that dividend growth at a company like ConocoPhillips would average a good 33% higher annually in the next 10 years than it has in the last five. That brings my projected rate of annual dividend growth to 7.71%, and the end dividend to $5.21 a share for an ending yield of 4.9%. You can use my pocket calculator to go through this exercise with any oil stock that now pays a dividend. From experience, let me tell you that if you want to find stocks that beat the income from a 10-year Treasury note, you'll need to look for either a very solid current yield, like that that offered by ConocoPhillips or a very, very substantial dividend growth rate. Anadarko Petroleum, for example, works even better than ConocoPhillips because, although you're starting with a meager 72 cent a share dividend and a 1% yield, the average annual five-year dividend growth rate has been a whopping 25.2%. That results in an end-of-10-years dividend of $6.81 a share and a yield of 9.3% from the current purchase price. And that's before any adjustments for a slightly higher one-year dividend growth rate of 28.6%. (In fact, in this case I'd advise revising that dividend growth rate down because as the dividend increases from 72 cents, the rate of growth will almost undoubtedly decline.) Three other stocks I'd run through their paces along with ConocoPhillips and Anadarko to see how their yields measure up 10 years from now include XTO Energy Good hunting. New developments on past columns 10 winning stocks for a stuck-in-the-rut market On April 20, Wolverine World Wide Transport winners will keep on trucking "Now that was a good quarter." At the risk of sounding like a broken record, I'll repeat what I said after Burlington Northern Santa Fe's 5 stocks for an up-and-down year On April 28, Hartford Financial Services Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Apache and Microsoft. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||
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