Is Chevron’s Dividend Sustainable?

Chevron’s Dividend: To Be or Not To Be? That is the Question.

Chevron (CVX) ponders an existential question as it cuts CapEx spending and sells debt to sustain its $8 billion dividend.

Oil prices have nearly doubled from their February lows to $48 a barrel, but still remain well below the range of the past decade. Unsurprisingly, Big Oil profits are dwindling, raising investor concern as to whether high dividend yields are sustainable.

While some Oil companies, such as ConocoPhillips (COP) have cut dividends to repair balance sheets, Chevron (CVX) has taken appropriate cost cutting measures to improve cash flow and maintain its quarterly $1.07 dividend. Factoring in these cost cuts, a rise in Oil may even lead to a dividend hike next year.

Management remains dividend-devoted

Chevron, the US’s second largest oil company, has weathered market ups and downs for nearly three decades — including oil at less than $10 a barrel in the 1990s — without cutting dividends.

Along with tumbling Oil prices, Chevron stock has dropped nearly 30% from its July 2014 closing high of $133.57. At the same time, the dividend yield has risen to 4.23%, as dividend yields move inversely with stock prices. This yield is significantly higher than the sub-3% dividend yield average of the past 2 decades. At its current high level, investors are worried if a dividend cut is inevitable.

Adding to uncertainty, CVX just suffered its worst quarterly loss in 15 years, swinging to a loss of $1.5 billion in the second quarter of 2016, compared with earnings of $571 million in the second quarter of 2015. Sales and other operating revenues were $28 billion, compared to $37 billion in the year-ago period.

Even as 2016 profits drop to a 12-year low, Chevron’s management remains committed to its $1.07 quarterly dividend. CEO John Watson has dubbed it, “ Our number one priority.” On the second quarter earnings call, CFO Pat Yarrington said “the board will continue to evaluate the viability and sustainability of an increased dividend in 2016”, without even mentioning the possibility of a cut.

Throwing out the bathwater, keeping the baby

A simple method to determine the reasonableness and safety of a dividend is to calculate “the dividend payout ratio” by dividing the dividend paid per share by earnings per share. A low dividend payout ratio means the company has plenty of cash to make the payment; a high ratio implies the company is not generating sufficient income to make the payment.

Chevron has kept its annual dividend rate at $4.28 since Oil started falling in 2014. When that dividend is divided by earnings per share, here’s how the last few years look:

2014: $10.14 earnings per share/ $4.28 = 42% dividend payout ratio

2015: $2.45 earnings per share/ $4.28 = 175% dividend payout ratio

2016: $1.29 (proj) earnings per share/ $4.28 = 331% dividend payout ratio

Clearly, 2015 and 2016 are a cause for concern and these high payout ratios are sustainable.

As net income drops with the price of Oil, management is taking steps to raise cash. They’ve dramatically reduced CapEx spending for 2017–2018 to a range of $17 — $22 billion from $35 billion spent in 2015. Chevron’s $5 billion share repurchase program was slashed to zero. And plans to divest up to $10 billion in oil field and other assets have been accelerated.

These prudent measures have lowered Chevron’s Oil price breakeven to $52 a barrel even after dividends. At the same Oil price in 2015, Chevron lost over $10 billion. With these cost savings in place and slightly higher oil prices, Chevron management expects to earn $5.08 in 2017, implying a dividend payout ratio of 84%.

Some analysts have highlighted concerns over leverage ratios as Chevron tapped the corporate bond market to maintain the $8 billion dividend. Debt-to-Equity ratios have risen from a low of 7% in 2012 to 30% currently. However, this level remains significantly lower than Chevron’s 58% Debt-to-Equity ratio in 1994 and its 63% peak in late 1999. In both instances, the dividend remained intact.

Low interest rates and room to maneuver make debt financing a viable option. Chevron is rated “AA” by S&P and is able to raise capital at a spread of 50 basis points over US Treasuries. If interest rates do happen to rise, this would coincide with inflation and higher Oil prices, meaning Chevron would generate more cash to service its existing debt.

The bottom line

The key takeaway is that Chevron’s management has taken aggressive measures to put the super major in a strong operating cash position. While the current dividend payout ratio is dangerously high, Chevron is positioned to maintain (and possibly raise) the $1.07 quarterly dividend in the coming year.

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