Shares of energy goliath ExxonMobil (NYSE: XOM) are down around 15% from their highs earlier this year. Income investors may be wondering if there's something going on that they need to know about. The answer is yes and no. Here's what changed, and why Exxon and its dividend are still safe.
The ups and downs
Although it operates across the upstream, midstream, and downstream sectors of the energy space, at its core Exxon is an oil and natural gas driller. These two commodities, however, can be volatile and, sometimes, their prices move quite swiftly. The recent drop in Exxon's shares is largely related to the ups and downs of oil and gas, which have both been relatively weak lately.
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This is simply a part of Exxon's business. It isn't going away, and it is something with which investors need to be comfortable. The stock will always go up and down with the price of oil and gas. That said, Exxon is one of the most conservative energy companies around. In other words, it is prepared for this type of volatility, and the dividend and company are still as safe as ever.
Still a safe income investment
The first place for dividend investors to look to assess dividend safety is usually the payout ratio. That's actually a problem here because of the top- and bottom-line swings that can occur when energy prices rise and fall. Currently, ExxonMobil's trailing-12-month payout ratio is around 80%, but it can spike above 100% when oil prices are weak. For example, in 2016 the payout ratio was around 140%. It can also dip very low when oil prices are high, dropping to around 25% between 2010 and 2012. It is hard to use this metric as a measure of dividend safety for this company.
The cash dividend payout ratio, which focuses on cash flow instead of earnings (dividends are paid out of cash flow, not earnings), is equally troubling since drilling for oil is a capital-intensive effort. Often there are large upfront costs to big projects that get covered by issuing debt or selling assets. Once these projects are up and running, however, they can provide years of steady income. Right now, Exxon is in the middle of a large spending program that it expects will lead to robust long-term results. The cost of these efforts, which may run as high as $35 billion a year through 2025, has pushed the cash dividend payout ratio above 100%.
This isn't new information, even if investors might find it a little disconcerting. But it has to be juxtaposed against Exxon's balance sheet, which is among the strongest in the energy industry. The company's financial debt to equity ratio is an ultra-low 0.14, which is well below most of its closest peers'. That gives the oil giant plenty of room on its balance sheet to add debt when it needs to support its dividend and capital spending plans through a weak patch.
That's exactly what it did during the oil bear market that started in mid-2014 -- a period in which many of its peers chose to freeze their dividend or, worse, cut them. For reference, Exxon has increased its dividend for 37 consecutive years, showing an industry-leading commitment to shareholder dividends.
Another metric that investors should be looking at to assess the safety of a company's dividend is the interest coverage ratio. This basically examines how well a company can handle the cost of its debt. It probably shouldn't be too much of a surprise to find that Exxon's modest use of leverage leads to strong interest coverage. Currently, it is covering trailing-12-month interest expenses by a robust 33 times. It is highly unlikely that Exxon will need to sacrifice the dividend so it can cover its debt costs.
One thing to worry about
So, looking at Exxon today, it appears to be a safe company with a safe dividend. That's true despite the fact that financial results will vary along with the price of oil and natural gas. And while there's no need to worry about Exxon right now, there are bigger-picture concerns that investors need to think about, notably the global shift toward noncarbon fuel sources.
Some of the company's peers are branching out into new areas, like electricity, to prepare for this long-term risk. Exxon, on the other hand, is basically doubling down on oil and gas. Exxon's internal projections suggest this is the right move. While the company is financially strong and the dividend is secure, you need to be comfortable with the long-term call on oil if you choose to invest here.
This article was originally published on Fool.com