(Bloomberg) -- Skyrocketing oil prices have helped make oil and gas producers the best performers in the stock market this year, triggering a rapid rise in dividend payments and a bonanza of special dividends.
Now, some investors are of the mind that those fat yields are here to stay even as crude prices retreat from $100 a barrel -- effectively transforming oil and gas producers from high-risk, high-reward wagers to safe income investments. With earnings season approaching and the stocks down more than 20% from their June high, the market is about to get a look at how determined the companies are to maintain those high payouts.
Dividend payments from large energy companies exploded in the third quarter, whetting investors’ appetite for more. S&P 500 Energy Index companies paid out $16.4 billion in cumulative dividends, which is up 15% from $14.3 billion in the second quarter and a whopping 49% from $11 billion a year ago, according to data compiled by Bloomberg.
“It’s a golden era for dividends and buybacks,” said Eric Nuttall, partner and senior portfolio manager at Toronto’s NinePoint Partners. High commodity prices have allowed energy producers to aggressively pay down debt, setting up a stable payout for shareholders, he said.
At the moment, oil producing stocks offer higher yields than the so-called high-yield indexes. The Energy Select Sector SPDR Fund (XLE), which holds large-cap energy companies, has seen dividend growth of 41% over the last year and pays a 4.2% yield compared with the Vanguard High Dividend Yield ETF’s (VYM) 3.2% dividend yield. The oil producers are also beating S&P 500’s “dividend aristocrats,” stocks with dependable histories of rising annual payouts. The yield on the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) is 2.2%.
“The industry has seen a permanent transition to almost a high-yield, income space,” Morningstar analyst David Meats said. “But that’s not to say that the numbers that you’re seeing today will persist.” The current high yields are compensation for the additional risk investors see in these cyclical stocks, he said.
As investors get paid, there’s also a prize for the oil and gas producers.
“Energy is trying to get out of the penalty box,” said Stacey Morris, head of energy research at Alerian VettaFi, noting that rising dividends are intended to attract new long-term investors and lessen the volatility in cyclical oil-producer shares. There is evidence energy equities are becoming less volatile and decoupling from crude swings in part due to those big payouts, she said.
The question is whether they can keep those high dividends if oil prices drop further. “What proves your ability to pay a dividend is a downturn,” she said.
Getting the answer to that will take time. Dividend aristocrats receive the title after raising dividends for 25 straight years. There are only two oil and gas producers, Exxon Mobil Corp. and Chevron Corp., among the S&P 500’s 64 dividend aristocrats.
Some portfolio managers are making long-term bets on the sector’s income potential. Toronto’s Ninepoint Partners, for example, launched a new energy income fund that’s 85% weighted toward oil and gas producers. Its largest holdings are oilsands producer Cenovus Energy Inc., natural gas producers Chesapeake Energy Corp. and Coterra Energy Inc., and shale darling Devon Energy Corp.
“Oil and gas is not this rags-to-riches, boom-to-bust investment anymore,” Canoe Financial partner and senior portfolio manager Rafi Tahmazian said by phone.
The Canoe EIT Income Fund includes oil and gas names Tourmaline Oil Corp., ARC Resources Ltd. and Canadian Natural Resources Ltd. among more traditional income stocks like insurance companies, banks and cigarette makers. Tahmazian looks for larger energy companies with higher quality resources for his income portfolio. He’s drawn to their sustainable dividend yields, instead of smaller, riskier firms.
Still, not all long-time income investors are on board with oil and gas producers.
“The oil industry is hard on capital, that’s the nice way of saying it,” Energy Income Partners Chief Executive Officer Jim Murchie said by phone. These companies historically “spend what they make” rather than holding cash for shareholders, he said.
“I don’t think leopards change their spots,” he said.
That’s the dividing line for income investors. Both Tahmazian and Nuttall say energy producers have shown spending restraint in the face of rising profits, and that capital discipline makes them confident the dividends can be sustained over the longer term.
“The spending has dried up,” Tahmazian said. “This is the easiest investing in my 31 years.”
(Updates dividend yield of Energy Select Sector SPDR Fund in fifth paragraph)
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Author: Geoffrey Morgan