This Energy Stock Just Boosted Its Dividend by 20%. Are More Hikes on the Way?

Companies -- like people -- can have a reputation. Some are steady; some are inconsistent. Often, this reputation comes with the territory. Consider the energy sector. It has a reputation for boom and bust cycles due to its dependence on volatile energy prices. But in the same way that a person can turn over a new leaf, companies get second chances too. One such company is Murphy Oil (MUR 0.02%)

Oil has surged, and so has Murphy's dividend.

In early 2020, the company offered a $0.25 dividend which was halved in May 2020, following the start of the pandemic. But, on Jan. 27, the board of directors for Murphy approved a $0.15/share quarterly dividend -- a hike of 20%. Murphy CEO Roger Jenkins noted that the increased dividend relies on the company's strategic plan, which assumes $65 oil prices. Of course, oil isn't trading at $65/barrel; it's over $90, which is great news for Murphy and its strategic plan. Even if oil prices do pull back from current levels, Murphy will generate significant cash flow -- which is exactly what it needs to execute its plan.

Image source: Getty Images.

Like many energy companies, Murphy dipped into the red during the pandemic. It posted seven-straight quarterly losses between Q4 2019 and Q2 2021. With no profits, the company used debt to fund ongoing operations -- and its overall debt ballooned as a result. Total debt peaked at $3.9 billion at the end of 2020.

But as oil prices have rebounded, profitability has returned. Murphy has posted back-to-back quarterly profits, and free cash flow has also picked up. After hemorrhaging cash (Murphy averaged a negative cash flow of $581 million between 2018 and 2020), the company generated $734 million of FCF in 2021. Much of the credit for this turnaround is due to a change in strategy -- prioritizing existing wells over new, more costly development projects.

Now, with cash flowing in, Murphy is paying down its debt -- total debt now stands at $2.5 billion (a reduction of 17% year over year). What's more, Murphy plans to retire more debt in the coming years -- with its ultimate goal of bringing total debt down to $1.4 billion by 2024. With the debt load easing and $521 million of cash on hand, management and the board of directors felt confident in returning more to shareholders through the new, higher dividend. 

Source: CFRA Research. Est = Estimated.

Regional diversity spreads out risk

The energy sector is risky. A long list of pitfalls awaits any company hoping to profit from extracting fossil fuels: natural disasters, labor strikes, regulatory barriers, and logistical snags -- just for starters. With so much that can go wrong, it's smart to spread your bets. 

Murphy boasts operations in several different geographic areas, but the bulk of its production is centered in three locations: Texas, Offshore in the Gulf of Mexico, and Western Canada. With 47% of Murphy's production coming from offshore wells in the Gulf of Mexico, hurricanes are a risk. Hurricane Ida impacted Murphy's operations in 2021. However, that risk will decrease over time as Murphy shifts its focus to Canada. CFRA research estimates that 53% of Murphy's proven reserves are located there, however, it only represents 30% of current production.

Eagle Ford shale -- located in Texas -- is the crown jewel in Murphy's portfolio. It's only 20% of production, but Murphy's wells in the region are its stars -- with over 50% exceeding the company's projected average daily flow from a given well. These wells are typically cheaper to operate.  

This geographic diversification minimizes the risk from any one event: a hurricane, a burdensome new regulation, or a dip in production in a specific area.

Can Murphy keep costs down?

Murphy is an income stock -- not a growth stock. Its success depends on how well management keeps its costs in check -- and whether the price of oil and gas remains elevated. Murphy can't control energy prices, but they have a plan to keep costs in check. Murphy has sold off assets in Malaysia and focused on gaining efficiencies from its existing Gulf of Mexico wells. Management has said capital expenditures for 2022 should range between $840 million and $890 million. By 2023 these costs should drop to $600 million, but production levels are set to remain steady.   

Analysts think Murphy's plan is on track. Earnings estimates have risen, with CFRA predicting $2.79/share in 2022 and $4.00/share in 2023. With the stock trading at nearly $33, Murphy has a forward P/E of 11.8 -- well below the S&P average of 25.7. The increased dividend means Murphy's dividend yield is up to 1.77% -- a modest but respectable amount.

So is Murphy a turnaround story worth investing in?

For a value investor, a P/E of 11.8 sure sounds good, but it's not the only consideration. The main risks to Murphy's strategic vision include cost inflation, lower drilling efficiency, weather, and regulatory setbacks. Any or all of these risks could drive up future capital expenditures, which in turn could lower earnings. But, there are also upside risks, such as higher prices for oil and gas and higher drilling efficiency.

When it comes to Murphy, Wall Street seems to think the upside outweighs the downside. The average analyst price target is $36.25 -- a 10% premium to its current price. Whether it's another hike to its regular dividend or a rise in stock price, it looks like Murphy Oil might be well on its way to turning over that new leaf.