Is This Huge Dividend Worth the Risk?

Ecopetrol yields 6.5%, but is the payout worth the risk?

Jul 23, 2014 at 11:45AM

Ecopetrol (NYSE:EC) is the largest oil and gas company in Colombia. Ecopetrol's most attractive quality is the company's dividend yield. At present, Ecopetrol offers a dividend yield of 6.5%, nearly double that of larger peers, such as ExxonMobil and Chevron.

Then there's Ecopetrol's valuation. The company currently trades at a P/E ratio of 10.9, compared to its five year average of 16, industry average of 13.7, and S&P 500 average of 18.6.

International player
Ecopetrol has a 60% market share of the petroleum market within Colombia. Additionally, the company operates within Peru and Brazil, as well as the Gulf of Mexico, where it is currently exploring for oil and gas.

All in all, Ecopetrol has just under 2 billion barrels of oil equivalent in reserve and 4,200 miles of pipeline. And over the past five years the company's growth has been more than impressive. Since 2009 annual revenue has more than doubled and net income has risen 150%.

However, the question is, why is Ecopetrol trading at such a lowly valuation despite its rapid growth? Moreover, the company's shares are currently trading at a near two-year low that would scare most investors away.

Behind the valuation
Undoubtedly, the main catalyst behind Ecopetrol's low valuation is the political situation within Colombia. With around 60% market share in Colombia, Ecopetrol is a heavily reliant on the country and its fortunes.

Last month, Colombia faced a general election and the current president, Juan Manuel Santos won by a fine margin. Santos has just been given a mandate to continue peace negotiations with the Revolutionary Armed Forces of Colombia, the Marxist terror group known as FARC.

Many analysts were concerned, that due to political pressures in the run-up to the elections, peace negotiations with FARC would fall apart. Due to political ideological differences across the political parties, some policymakers wanted to abandon negotiations and return to war.

But there is no doubt that even after this victory, the political environment within Colombia remains volatile, this is the one thing that the market hates, uncertainty. Unless there is a long-standing peace agreement between the rebels, or the peace negotiations fail to show significant progress over the next year, the president risks quickly losing credibility, which will end up further strengthening his detractors on both the left and the right.

Further, Ecopetrol is a state-controlled oil company, so any political issues are compounded for investors.

Exploration success
Still, despite concerns at home, Ecopetrol is making strong progress overseas. The company recently raised its interest within the Gulf of Mexico to 149 exploration blocks, partnering with Murphy Exploration and Production for the development of some regions.  

These blocks allow deep sea hydrocarbon exploration in water depths of over 221 meters for a 10-year period. There has also been progress with partner Royal Dutch Shell (NYSE:RDS-A) at the Rydberg well, which recently encountered approximately 400 feet of net oil pay.

Ecopetrol's success within the Gulf of Mexico is part of the company's internationalization strategy, designed to reduce its dependence upon South America.

It is expected that the Rydberg well, will yield 100 million barrels of oil for Royal Dutch Shell and Ecopetrol, a sizable discovery. However, Ecopetrol only has a 28.5% interest in the partnership that made the discovery. Shell holds a 57% stake while Nexen Offshore owns the remaining 14.3%.

Nevertheless, for Ecopetrol, this discovery was extremely important as the company acquired seven additional exploration blocks near the find at Rydberg; the group plans to explore those areas in the near future.

The bottom line
The bottom line is the fact that Ecopetrol is highly exposed to political instability within Colombia. Ecopetrol is trying to expand internationally, however, with more than half of its sales still conducted within the unstable country, the risk might be too great for some investors.

That said the company's low valuation and high dividend yield are attractive, although the reward might not be worth the risk in this case. 

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Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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