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Article Thesis
Oil prices may be lower than they were at their peak last year, but they have steadily climbed over the last couple of months. Gasoline prices have soared, making fueling up a costly endeavor once again. In this report, we will showcase 3 energy companies that benefit from higher oil prices and that can, with their dividends, help investors when it comes to paying more for gasoline.
Oil Prices: Up And Down And Up
Crude oil is a commodity, and thus its price can swing up and down quite a lot. We saw that over the last two years:
Oil prices had been recovering from the pandemic’s impact — lockdowns, travel restrictions, and so on — in late 2021, and oil prices soared even higher beginning in 2022 when Russia invaded Ukraine. Oil flow restrictions, sanctions, and so on caused oil prices to soar above $120 per barrel in the spring and summer of last year, but they started to wane during the second half of the year. Rising interest rates made market participants worry about a potential recession, and since recessions usually cause lower oil demand — e.g. due to less air travel — the macro sentiment when it comes to oil prices got weaker and weaker. Oil headed lower again, trading below $70 per barrel at times.
Over the last two to three months, however, oil prices have risen quite considerably. Supply cuts by Russia, Saudi Arabia, and overall OPEC+ have caused a weaker-than-expected supply picture. At the same time, most economies have turned out to be more resilient than previously feared — the US economy and most other economies are continuing to grow, and it looks like central banks might be able to successfully engineer a soft landing. With recession worries dwindling and travel demand remaining strong, the supply-demand picture in the global crude oil market has turned decidedly in favor of oil producers, with crude oil trading north of $90 per barrel again. That’s an oil price level that allows for massive profits for most energy companies, as they have reduced their break-even prices during the pandemic via efficiency investments, cutting unnecessary employees, and so on. In fact, some major oil companies such as BP (BP) are positioning their portfolios to make them solidly profitable with oil prices at $60 per barrel — with oil trading at one and a half times that price right now, they are gushing cash.
Of course, the other side of the story is that consumers and businesses that need to buy oil-derived products are now paying a lot more than they did a couple of months ago, with soaring gasoline prices (now at the highest level this year) making fueling up quite costly once again.
With high oil prices making fueling up (and heating) more costly, while higher oil prices result in bigger profits for energy companies at the same time, buying shares in these energy companies could be a good way to hedge one’s oil price exposure. If oil stays high or rises even higher — Goldman Sachs (GS) has just lifted their oil price target to $100 per barrel — then being exposed to oil equities will be beneficial, and the dividends from these stocks will help consumers pay for more expensive gasoline.
Here are a couple of energy stocks that will benefit from higher oil prices and that offer nice dividend payouts at current prices, with the potential for dividend increases going forward.
1: Suncor Energy Inc.
Suncor Energy (SU) is a major Canadian oil sands player that has a large asset base, massive reserves, strong production levels, and that has a successful track record.
Oil sands assets have high upfront costs but low decline rates and low proportional costs, which is why their break-even prices are rather low, once these assets are running. Since these assets can produce oil for decades, there is little reason to worry about reserve replacement, which is an advantage of oil sands players such as Suncor Energy compared to shale oil players, for example, as the latter oftentimes have smaller reserves and higher decline rates.
Suncor Energy is solidly profitable with oil trading at $70 or so, as the company generated US$1.4 billion of profit during the second quarter of the current year. Meanwhile, cash flow was around US$2 billion during the quarter. For a company that is currently valued at US$44 billion, that’s a pretty appealing earnings and cash flow pace. But oil prices are currently significantly higher than they were during the second quarter, on average, meaning profits during the current quarter — and possibly Q4, unless we see a major oil price pullback — should be considerably stronger.
Suncor Energy uses these profits and cash flows in several ways. The company wants to bring down its debt levels further, while shareholder returns via dividends and share repurchases also play a large role. At current prices, the dividend yield is 4.5%, and there is ample room to lift the dividend further — after all, the dividend costs just around US$2 billion per year right now, which is comparable to the company’s cash flow during the second quarter alone.
2: Shell plc
Shell plc (SHEL) is a British/European oil supermajor. While the company has been vocal about increasing its green investments in recent years, the company is still very much an oil and gas player — that’s where the vast majority of profits and cash flows are generated. The new CEO also has dialed back the green energy rhetoric and plans to utilize a more returns-focused approach when it comes to green and new energy investments.
Compared to US peers Exxon Mobil (XOM) and Chevron (CVX), Shell and the other European supermajors — BP (BP) and TotalEnergies (TTE) are pretty cheap:
Shell, BP, and TotalEnergies all trade at less than 4x forward EBITDA, while Exxon Mobil and Chevron are valued at 6x to 7x EBITDA today. Even the valuation of XOM and CVX is pretty low in absolute terms, but the others are even bigger bargains.
Shell currently offers a dividend yield of 4.1%, which is well north of the broad market’s yield and also more than what one can get from XOM and CVX. And yet, the payout ratio is very low: Shell’s dividend costs $8.6 billion per year, while free cash flows totaled $42 billion over the last four quarters. Shell thus has massive room to increase the dividend in the coming quarters and years, and I expect that this will happen, as Shell will try to get the dividend to the pre-COVID level eventually.
3: Devon Energy
Devon Energy Corporation (DVN) is a smaller oil company that is focused on shale plays in the United States. While that has the disadvantage of smaller reserves, compared to oil sands players such as Suncor, Devon Energy could be attractive due to another trait: Its variable dividend strategy.
Devon Energy offers a base dividend of $0.20 per share per quarter, which makes for a dividend yield of a little less than 2%. But on top of that, Devon Energy offers variable special dividends every quarter. Over the last year, the company has paid out $3.45 per share, which makes for a dividend yield of 7.3% at current prices. While the special dividends experience ups and downs, which is why there is no guarantee that they will be equally high going forward, the rising oil price environment should be a major tailwind for profits and thus also for DVN’s special dividends. Even based on the payout during the most recent quarter, the dividend yield is very solid, at 4.2%, and it is, I believe, highly unlikely that we will not see a dividend increase as oil prices rise.
Devon Energy trades for just above 8x forward earnings, which is a quite low valuation. Since oil prices have risen fast in recent weeks, analyst estimates could be too low, which would translate into an even lower “real” valuation.
Takeaway
Rising oil and gasoline prices hurt consumers — why not be on the other side of the trade and benefit from the price increase? I believe that energy companies can be attractive investments overall, and they help hedge against higher fuel prices. Suncor, Shell, and Devon are among the energy companies that could be nice income investments going forward in my view.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
