- By John Engle
In recent years, Exxon Mobil Corp. (XOM) has found it increasingly difficult to preserve its vaunted dividend. Even last year, as the Coronavirus pandemic wrought havoc on the already-oversupplied oil market, Exxon succeeded in keeping the dividend intact, thanks in large part to new debt issuance.
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Unfortunately, while Exxon's dividend managed to survive the latest crisis, its future is far from certain.
Protecting the dividend at all costs
Maintaining and expanding dividend payments has long been a top priority for Exxon's management, a fact that has made it a "dividend aristocrat," a rare title reserved only for those companies in the S&P 500 index that have increased their dividend every year for at least 25 years. In the last few years, however, Exxon has found it ever more difficult to maintain this rarefied status.
Years of global oil oversupply and the resulting low oil prices have diminished Exxon's cash flow. In spite of this, Exxon has insisted on growing its dividend and keeping its place as a dividend aristocrat. In 2019, Exxon paid $14.7 billion in dividends despite generating only $3 billion in free cash flow, and 2020 was even harder on the dividend. Things got so bad that, in April, the price of oil actually dipped below $0 a barrel, albeit briefly.
Unsurprisingly, the oil price collapse led a growing chorus of analysts to question Exxon's ability to maintain its dividend. But Exxon was not willing to give it up. Instead, it engaged in a raft of cost-cutting measures, including a steep reduction in planned capital spending.
Using debt to plug the widening gap
Unfortunately, cuts alone have not been enough. To keep funding its expensive dividend, Exxon has found it increasingly necessary to turn to debt markets. As of Sept. 30, Exxon's total debt stood at $68.8 billion, up 46% from the $47.1 billion it reported a year earlier. Much of this debt has gone toward funding dividend payments.
While the oil market has lately shown signs of recovery along with the global economy, Exxon may still have to return to capital markets this year in order to fund its dividend. According to a November report by MKM Partners, an equity research and investment firm, Exxon may have to raise as much as $8 billion in new debt in order to cover dividend payments through 2021. This would represent a 12% increase in Exxon's leverage.
Moreover, while the price of oil has risen considerably from its crisis low, there remains some uncertainty in the global marketplace. At around $55 per barrel, oil remains well below historic norms. It is also uncomfortably close to the $49 per barrel Exxon needs to cover its dividend and planned capital expenditures.
Beware the rising tide of leverage
In my view, Exxon's battle to preserve its dividend last year can be deemed a qualified success. While the company did not have to suspend or reduce its dividend in 2020, it did feel compelled to announce in October that payouts would not increase for the first time in nearly two decades.
For now, Exxon has preserved its dividend, as well as its coveted dividend aristocrat status. But this has come at the cost of falling growth investment and rising debt. Exxon's current debt is manageable. Adding another $8 billion to fund the dividend in 2021 would not be much more onerous. Over the long run, however, the combination of reliance on debt to fund dividends and a failure to invest in new projects may begin to weigh on Exxon's financial performance.
Disclosure: No positions.
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This article first appeared on GuruFocus.