Investors are often wary of high dividend yields as they can signal that there isn't much confidence in a company's ability to sustain its payout.
With a yield of 6.9%, Ecopetrol's (NYSE:EC) dividend seems too good to be true. Indeed, when compared to the company's sector peers, Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM), both of which support dividend yields in the region of 3%, investors have every reason to doubt the company's payout.
But what's the real story behind Eco's dividend yield, and how much longer can it last?
The best place to start analyzing the sustainability of any dividend payout is to take a look at company financials.
Unfortunately, one thing that immediately becomes apparent when analyzing Ecopetrol's dividend yield is the fact that the company, like it major peers, is overspending on capital projects. This does indicate that the dividend could come under pressure.
Ecopetrol is planning on spending $10.6 billion during 2014 on capital projects. $8.4 billion of this will be directly spent on Ecopetrol's projects with another $2.2 billion going toward subsidiary projects. This $10.6 billion budget is an 11% increase on 2013 capital spending levels.
Now, Ecopetrol has stated that, assuming the company's crude basket (price achieved for oil sold) remains at levels close to those of 2013 (around $100 per barrel), then Ecopetrol will have to find an additional $1 billion, which the company states could be achieved by "indebtedness."
With Ecopetrol spending more than it can afford on capital projects, it looks as if management is paying the dividend from the company's cash balance. Indeed, at current exchange rates, based on figures from the nine months ending September 30, Ecopetrol's dividend cost the company a total of $4.3 billion.
As Ecopetrol is already estimating that it will overspend on capital projects by $1 billion for 2014, it would appear that the company is going to have to find at least $5.3 billion in working capital to remain liquid through 2014.
That being said, Ecopetrol shouldn't have a problem raising the cash it needs, as at the end of the third quarter net debt-to-equity was only 9% and net debt-to-assets was less than 5%. The company's assets are worth $62 billion at current exchange rates.
Following industry trends
Still, while it is clear the Ecopetrol will not be able to fund both capital spending and dividend payouts from free cash flow during 2014, the company's position is no different from that of Exxon and Chevron.
In particular, Exxon plans to spend around $37 billion during 2014 on capital projects, the company spent $42.5 billion during 2013. However, the company only generated $45 billion in cash from operations while paying out a further $27 billion to shareholders.
All in all, Exxon spent just under $70 billion in total during 2013, while only generating $45 billion from operations. It is likely that the company will report similar numbers during 2014.
Chevron meanwhile plans to spend around $40 billion on capital projects throughout 2014, down from $42 billion during 2013.
But like peer Exxon, Chevron's cash flow from operations did not cover capital expenditures or shareholder returns. In total Chevron paid out $54 billion development costs and shareholder returns during 2013 but only generated $35 billion from operations.
After taking the figures above into account, Ecopetrol's spending deficit appears to be the industry norm and nothing to worry about.
The bigger picture
Even though Ecopetrol's dividend looks secure based on current figures there are still other factors to consider. For example, the company had a poor 2013 as pension contributions and changing tax rules crimped net income by 11.3%; these factors are unlikely to persist through 2014.
What's more, Ecopetrol reported a rising number of attacks on its pipelines by rebel groups in Colombia, although once again these attacks are unlikely to persist through 2014 as peace talks have been brokered between rebel factions and the government.
Still, despite these risks the company has reported a number of new discoveries this year, and throughout 2013 the company achieved a reserve replacement ratio of 1.39, implying that for every one barrel produced, 1.39 were discovered to fill its place.
All in all, this short analysis of Ecopetrol does not do the company justice, and there are many other reasons the South American producer looks attractive over its peers. Nevertheless, what can be said is that Ecopetrol's dividend yield looks safe for the time being based on the company's current income/expenditure and clean balance sheet.
Rupert Hargreaves owns shares of Chevron. The Motley Fool recommends Chevron. 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.