Exxon Mobil (XOM): The Low Dividend Safety Can’t Be Ignored

Exxon Mobil Corporation (XOM) announced yesterday that the regular quarterly cash dividend payout would remain the same in 2020. This ends a 13-year streak of dividend increases. Exxon Mobil is still a Dividend Champion and a Dividend Aristocrat for now since the annual increase streak is still there since the dividend is normally increased in the first quarter. The stock was also unceremoniously kicked out the Dow Jones this year. The stock was on the Dogs of the Dow 2020 list as well at the start of the New Year. Exxon Mobil’s stock price keeps falling and the dividend yield keeps rising. The current yield seems enticing at over 11%. Some are convinced that Exxon Mobil is a great deal. But the low dividend safety for Exxon Mobil cannot be ignored by investors. If oil prices remain low and the company cannot cut costs fast enough the dividend, which costs about $15 billion annually will need to go. The low dividend safety of Exxon Mobil can’t be ignored and so let’s examine it in greater detail.

Overview of Exxon Mobil

Exxon Mobil traces its history back to 1870. Both Exxon and Mobil are descendants of Standard Oil, which was founded by John D. Rockefeller. Standard Oil Co. of New Jersey eventually became Exxon and Standard Oil Company of New York became Mobil. The two companies announced a merger in 1998 that was completed in 1999 reuniting the companies. It was the largest corporate merger at the time and the combined company was largest oil major and the largest public energy company.

Today, Exxon Mobil operates in three business segments: Upstream, Downstream, and Chemical. Upstream includes deep water, regular oil fields, and LNG. Downstream is refineries and distribution and retail. At end of 2019, Exxon Mobil had roughly 23,857 wells and 22.4 billion oil-equivalent barrels of proven reserves. The company is the largest oil producer in the U.S. Major brands include Exxon, Mobil, and Esso. Total revenue was $255,583 million in 2019.

Exxon Mobil’s Dividend and Growth

Exxon Mobil has paid a continuous dividend for over 100 years dating back to 1882. The company has also paid a growing dividend for 38 consecutive years making it a Dividend Champion. The stock is also a Dividend Aristocrat. Exxon Mobil’s dividend has been a source of income for many individual investors and retirees. The consistent dividend growth made it a popular stock for dividend growth investors. The chart below shows the dividend payout and growth rate over the past decade with the stock price superimposed (green). The consistent decline in stock price to near 20-year lows since 2014 has pushed the dividend yield up over 11%. This is the highest yield in the past decade. Note that the decline in Exxon Mobil’s stock price has accelerated in 2020 due to low oil prices and low demand caused by the COVID-19 pandemic.

Exxon Mobil Announces Dividend To Remain Constant

Exxon Mobil announced today that it would maintain its quarterly regular cash dividend at $0.87 per share. This means that the dividend will not be increased in 2020 ending the streak of dividend increases. Specially, the company stated:

The Board of Directors of Exxon Mobil Corporation (NYSE:XOM) today declared a cash dividend of $0.87 cents per share on the Common Stock, payable on December 10, 2020 to shareholders of record of Common Stock at the close of business on November 12, 2020. This fourth quarter dividend is at the same level as the dividend paid in the third quarter of 2020. Through its dividends, the corporation has shared its success with its shareholders for more than 100 years.

Exxon Mobil also indicated that job and cost cuts could be announced. Along those lines the company released a statement saying that 1,900 employees from its headquarters will be affected by U.S. staff reductions. The company posted its first back-to-back quarterly losses in about 36 years. The oil major is projected to have a full-year loss of $2 billion. The issue for Exxon Mobil is that the dividend costs about $15 billion in cash per year and with oil prices at about below about $40 per barrel the company is likely not making money with the current cost structure. Reportedly, Exxon Mobil needs the price of oil at about $50 per barrel to break even. Some analysts peg it slightly higher at between $50 and $60 per barrel. This leads to low dividend safety and places the dividend at risk for a cut.

Exxon Mobil is seemingly committed to its dividend and has made that clear in the recent Q3 2020 earnings conference call. The company’s Principal Financial Officer stated:

And finally, there will be no change to our capital allocation priorities of investing in industry advantaged projects, maintaining a strong balance sheet and paying a reliable dividend. The progress we’ve made this year gives us confidence as we head into 2021…

And while we may not see a return to average earnings in the near term, we should at least move to the bottom end of the historic range, which we see as the minimum levels demonstrated by a decade of industry experience. This is the basis upon which we are building next year’s plan. If we see a recovery, just to the bottom of the 10 year range, and our Brent crude price in the range of credible third party estimates, we will be able to maintain the dividend while holding gross debt flat with second quarter levels.

In the short term, you’ve seen adjustments in our capital allocation, but our long-term capital allocation priorities remain unchanged; investing at advantaged projects, maintaining a strong balance sheet and paying a reliable and growing dividend. We’re developing a 2021 plan consistent with the uncertainties and in line with the simultaneous low margins and prices in each of our businesses.

Exxon Mobil Low Dividend Safety Can’t Be Ignored

The high dividend yield of over 11% is enticing to say the least. The problem though is that yields at this level have typically signaled that the dividend is at a risk for a cut. This is a real risk as other oil majors including Royal Dutch Shell (RDS.A), BP PLC (BP), and Occidental Petroleum (OXY) have all cut their dividends this year in response to low oil prices and the coronavirus pandemic. The list of energy companies conducting a dividend suspension or cut during the COVID-19 pandemic is even longer. From that perspective, the low dividend safety of Exxon Mobil can’t be ignored.

I like to take a look at three dividend safety metrics: earnings, cash flow, and debt. It is important to me as a dividend growth investor for all three to meet my criteria. Granted, there can be short-term fluctuations that results in a stock not meeting my criteria. But those are usually transient and not long term. Let’s do a deep dive into Exxon Mobil’s dividend safety.

For the first dividend safety metric, from an earnings perspective the dividend is not well covered. In 2019, the dividend payout was $3.43 per share and diluted earnings per share was $3.36. This meant that the payout ratio was 102% and the dividend was not covered by earnings. This is generally not problematic on a temporary basis. But continually low price of oil has also made the forward dividend not well covered by earnings. The forward dividend is $3.48 per share in 2020 and the company is expected to have a loss of ($0.39) per share this year. If oil prices remain low the dividend payout will likely not be covered by earnings in 2021 either.

The dividend is not well covered by cash flow either, which is the second dividend safety metric. On a trailing basis, operating cash flow was $29,716 million in 2019 based on data from TIKR*. Capital expenditures were $24,361 million giving free cash flow of $5,355 million. The dividend required $14,866 million so clearly the dividend was not covered at all by free cash flow. The dividend-to-FCF ratio was about 278%, which is way above my threshold of 70%. Granted, capital expenditures were elevated in 2018 and 2019 compared to the 2016 – 2018, but there are still lower than the level from 2010 to 2015. How does Exxon Mobil continue to pay its dividend? It must issue debt and thus impacting the balance sheet. On a forward basis, cash flow will be the same or lower than in 2019. The dividend will cost about $15 billion and capital expenditures will be elevated and possibly more than in 2019. This means that Exxon Mobil will need to issue more debt to pay its dividend unless it can cut costs fast enough and deep enough.

The amount of debt on Exxon Mobil’s balance sheet is rising. Debt is the third dividend safety metric. The chart below shows the growth in debt over the past decade. At the end of Q2 2020, short-term debt was $22,952 million, long-term debt was $46,563 million and this was offset by only $12,576 million in cash, equivalents, and short-term investments according to data from TIKR*. The main problem for Exxon Mobil from the context of debt is that interest coverage is weakening, and the leverage ratio went over 4X in the second quarter due to weak EBITDA. This is not completely in Exxon Mobil’s control as low oil prices at sub-$40 is likely not profitable or probably near breakeven at best. But Exxon Mobil cannot control the price oil and will need to cut costs to strengthen the balance sheet. One possibility is that the dividend payout could be cut reducing cash flow requirements.

Our deep dive into Exxon Mobil’s dividend safety shows that the dividend safety is very low based on the three metrics of payout ratio, dividend-to-FCF, and debt.

Final Thoughts on Exxon Mobil Low Dividend Safety Can’t Be Ignored

It is clear that COVID-19 has adversely affected oil demand. Prior to the pandemic oil supply was robust and a significant amount was in storage, but demand was comparatively high. Today, oil prices are low at sub-$40. The problem is that as oil prices rise more oil wells will come back online. Technological advances have reduced the costs to extract oil from deep water, by fracking, and from oil sands. This suggests that even if demand rises oil prices will remain low. There is an argument that as more people drive and take flights then demand will return more normal levels. This is seemingly the position being taken by Exxon Mobil’s management as it works to preserve the dividend payout. But that view largely ignores the structural changes going on for remote working and virtual learning. Some of these will be permanent even after the coronavirus pandemic subsides and in turn these changes will reduce demand for oil.

The market is punishing energy stocks as a group and not just Exxon Mobil. If we use the Energy Select Sector SPDR ETF (XLE) as a proxy then the trailing returns for energy are negative for the past 1-year, 3-years, 5-years, 10-years, and 15-years (using month end data). I believe that the issue is structural due to changes in demand and ability to rapidly provide supply. In the early-1980’s energy stocks made up almost 30% of the market value in the U.S. and 17% of the market as recently as 2008. Currently, energy is now the smallest of all sectors in the U.S. at about 2.2% according to the sector breakdown from the Vanguard Total Stock Market ETF (VTI) at the end of Q2 2020.

Ultimately, the low dividend safety of Exxon Mobil can’t be ignored. This combined with a poor outlook for oil prices and demand means that Exxon Mobil may not provide the returns of the past. My personal opinion is that Exxon Mobil’s dividend is at risk and investors should be wary. A hypothetical 50% cut to the dividend payout would significantly improve dividend safety metrics and reduce cash flow requirements.

Related Articles on Dividend Power

• Procter & Gamble (PG) Dividend Safety
• AbbVie (ABBV): Dividend Safety Pressured by Humira