By now, most investors know that oil has crashed. After trading above $100 per barrel at its 2014 peak, West Texas Intermediate now barely hovers above $50 per barrel. The same pattern has played out for Brent crude, the international benchmark. This has taken down oil stocks of all shapes and sizes, both in the United States and abroad.
With profits collapsing across the energy sector, investor attention should now be fixed on dividend sustainability. After all, companies can only distribute to investors what they earn. And due to the oil crash, a number of exploration and production and oil drilling companies like LINN Energy and Transocean have cut their dividends to save much-needed cash.
For these reasons, investors should know that three of the biggest members of Big Oil, BP (NYSE:BP), Royal Dutch Shell (NYSE:RDS-A)(NYSE:RDS-B), and Chevron (NYSE:CVX), should continue to make their generous dividend payments for the foreseeable future.
Integrated business model provides balance
Certain types of energy companies are more vulnerable than others to falling oil prices. Exploration and production companies, as well as oil drillers, are highly reliant on supportive oil prices. This is not as true when it comes to the integrated majors like BP, Shell, and Chevron. That's because the integrated majors hold a key advantage, which is their diversified operational structure.
Integrated majors have downstream businesses, including refining, that complement their upstream exploration and production businesses. Downstream earnings usually improve when oil prices decline because pricing spreads typically increase, which leads to higher margins and profits. This has played out so far, and has served as an insurance policy of sorts.
This is helping earnings stay afloat for Big Oil. Chevron's total profits fell 10% last year, to $19.2 billion. This was due mostly to Chevron's oil and gas exploration and production, where profits declined by 18% in 2014. However, downstream refining served as a nice offset to the upstream deterioration. Thanks to stronger refining spreads, downstream profits nearly doubled, to $4.3 billion, for the year.
BP lost $4.4 billion last quarter due to the crash in oil prices and this dragged down the results for the entire year. Earnings per share fell 65%, to $2.63 per ADS, which looks really bad. But despite the terrible fourth quarter, BP still generated $32.8 billion in operating cash flow last year, up from $21.1 billion in 2013.
For its part, Shell's total earnings fell 8%, which is disappointing, but its resilience is impressive considering the huge collapse in oil prices. Like Chevron and BP, Shell was also boosted by its downstream unit. Shell's downstream earnings rose 40% last year.
Capital discipline will boost cash flow
Another reason to be optimistic that BP, Shell, and Chevron can maintain their dividends is because they are raising cash by cutting capital expenditures -- and in some cases, through asset sales, as well. Since they are such huge companies with a broad range of businesses, it's not difficult to find ways to boost cash flow through strategic asset management. BP announced it will cut 2015 capital spending by approximately $2.9 billion from the previous year's budget, and plans to divest $10 billion worth of assets by the end of this year. These moves will free up cash to keep dividends flowing.
Shell sold $15 billion of assets last year, and is deferring spending in many areas. Management states its potential future capital spending will be trimmed by more than $15 billion for 2015-2017. Meanwhile, Chevron has set its capital budget at $35 billion, which represents a 13% cut year over year. Again, these measures, while difficult, will help support their high dividends.
Dividends are secure
While some companies in the energy sector have not been able to maintain their dividends through the oil crash, Big Oil looks built to survive. BP, Shell, and Chevron are taking the necessary steps to fortify their businesses. They are selling off assets deemed non-critical to future growth, and each will cut spending significantly this year.
BP, Shell, and Chevron should continue to generate enough cash flow to maintain their 4%-6% dividend yields. Investors looking for income may want to consider these stocks, since their dividends yields are at multi-year highs, and their valuations are near multi-year lows. With the capital preservation measures in place, it looks as though investors don't have to worry about their dividends.