Interactive Investor

Safest oil industry dividends

1st December 2015 14:34

Lee Wild from interactive investor

Oil companies are much more efficient than they were 12 months ago, so at least the pain meted out by low oil prices has not been wasted. They've slashed bloated budgets and improved capital allocation, two issues which had troubled investors and affected returns.

This trend should accelerate in 2016 - and have positive consequences for industry dividends.

Over 90 pages of research, Barclays oil analyst Lydia Rainforth and her team ruminate over the industry's near-term future and sustainability of payouts. And their conclusions, if proved correct, will be welcome news to oil investors.

"It is this increased focus on capex and opex discipline that should literally pay dividends for the oil companies and, whilst 2016 remains a transition year, by 2017 we see all companies covering dividends and capex from organic cashflow, with balance sheet strength used in the interim," says Rainforth.

Record oil yields 'not sustainable'

Understandably, dividends are the big question right now. Only during the financial crisis of 2008/2009 have yields been higher for the oil sector, something Barclays believes is not sustainable.

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"Our strongly held view is that the companies are not over-distributing, but that they have been overspending in recent years," explains Rainforth. "As such, a reduction in spending should help sustain dividends in the vast majority of cases, even in the case of a $40 per barrel long-run environment."

"We see the current implied yields for the sector as simply too high and further confirmation of our view that the sector is undervalued."

Barclays' base case scenario envisages a recovery in the oil price to $85 a barrel (/bl) by 2020, from around $45 currently - although expectations for 2016 are cut to $60/bl from $70/bl.

"With the exception of BG, each of our 'overweight' stocks - Royal Dutch Shell, BP and GALP - show potential upside in each of our scenarios." 

And Barclays is certainly a fan of the big two.

"Shell's current dividend offers over a 7% yield and is at a level at which, over the past 25 years, the company has not traded sustainably. Our dynamic modelling does show that, provided the management does deliver on our expectation of capital discipline, the dividend can be kept in all scenarios."

And as for BP, discipline on both capital and operational expenditure - plus a robust production outlook - should secure the payout. "This should enable BP to sustain the existing dividend and potentially resume growth in shareholder distributions post-2017," according to Barclays.

"With the shares offering close to a 7% yield and over 50% potential upside to our 600p per share [net asset value] based price target we rate the stock 'overweight'."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.