Updated on September 18th, 2020 by Aristofanis Papadatos
In general, energy stocks are highly regarded among income investors for their high dividends. This makes the sector a favorite of income investors looking for potential high yield stocks.
There are many energy stocks that fall on our list of high-dividend stocks. You can download your full list of all 300+ stocks with 5%+ yields, along with financial metrics like dividend yield and payout ratios, by clicking on the link below:
The recent and massive decline in oil prices has wreaked havoc among the global oil supermajors. The recent action by Saudi Arabia to increase production has exacerbated a global supply glut of oil. Making matters worse, the spreading coronavirus threatens to cause a global recession, which would result in a significant decline in oil demand.
Taken together, these forces have caused huge declines in the share prices of many oil companies in recent weeks. Because of this, investors should be particularly careful in their choices. Investors should also expect continued volatility in oil stocks, and only investors with a high tolerance for risk should consider buying energy stocks.
That said, for investors with a long-term focus and a high level of risk tolerance, multiple energy stocks appear to be undervalued due to their massive declines in share price. This has also resulted in elevated dividend yields across the energy sector. This article will discuss the 6 biggest global oil supermajors that we believe are attractive for long-term income investors.
Table of Contents
The terms “Big Oil” and “super-majors” are interchangable, and refer to the 6 largest oil companies that aren’t state owned. The 6 Big Oil supermajors are:
In this article, we will rank the six oil supermajors based on their expected 5-year returns. We calculate expected returns based on the combination of valuation changes, expected earnings growth, and dividend yields. The stocks are listed in order of annual expected return, from highest to lowest.
Supermajor Big Oil Stock #1: Royal Dutch Shell (RDS.A)(RDS.B)
- Expected Returns: 19.4%
Royal Dutch Shell is an oil and gas supermajor, the second largest behind Exxon Mobil in terms of annual production volumes. Shell is headquartered in London (UK) as well as in Den Haag (Netherlands). There are two types of shares of the company; RDS.A shares, listed in the Netherlands, and RDS.B shares, listed in the United Kingdom.
The coronavirus crisis has caused an unprecedented collapse in the demand for oil products this year. International Energy Administration (IEA) expects the global demand for oil products to slump from 100.1 million barrels per day in 2019 to 91.7 million barrels per day this year. A sharp recovery is expected next year but only if a vaccine against the virus is developed by early next year.
In late July, Royal Dutch Shell reported (7/30/20) financial results for the second quarter of 2020. The pandemic caused a plunge in the prices of oil, LNG and gas, as well as in refining margins. The integrated gas segment, which had remained resilient in the first quarter, saw its earnings slump 79% over prior year’s quarter due to depressed gas prices. Due to all these headwinds, Shell posted an 82% plunge in its adjusted earnings.
As shown in the slide below, Shell did its best to withstand the unprecedented crisis by reducing its operating expenses but the depressed commodity prices and margins almost fully offset this effort.
Source: Investor Presentation
In late March, at the point of maximum pessimism amid the pandemic, Shell’s management stated that the dividend was safe but in April Shell cut its dividend by 66%. It was the first dividend cut for Shell since World War II. On the one hand, the misleading stance of the CEO of the company is certainly disappointing. On the other hand, Shell and Total were the only oil majors that posted a profit in the second quarter.
Shell acquired BG Group, a deep-water natural gas focused upstream company in 2015, in a $53 billion deal. Shell grew its output considerably thanks to that acquisition, but its output has remained flat in the last three years. Management expects new projects to contribute 0.25 million barrels per day this year and 0.3 million barrels per day after 2021.
That output is likely to be offset by the natural decline of existing oil fields and hence we do not expect Shell to grow its output meaningfully in the upcoming years. This is in sharp contrast to the other oil majors, such as Chevron, BP and Total, which have been growing their production at a fast clip in recent years.
The stagnation has resulted from the natural decline of the fields of Shell and its extensive asset divestments, which helped fund the expensive acquisition. These two factors have also caused the duration of the reserves of Shell to fall for six years in a row and reach 7.9 years, which is much shorter than the average duration of the peer group (~11 years).
On the other hand, during the previous downturn of the energy sector, between 2014 and 2016, Shell drastically reduced its operating expenses and invested in high-quality, low-cost reserves, which have rendered the company more profitable than in the past at a given oil price. Shell posted record organic free cash flows of $31 billion in 2018 even though Brent was about -40% lower than it was before the previous downturn.
We expect 11% annual earnings per share growth through 2025 off their mid-cycle level of $2.97 (5-year average), primarily thanks to higher commodity prices. In addition, Shell stock is currently trading at 8.8 times its mid-cycle earnings, lower than our fair value estimate of 11. If the stock reaches our fair valuation level in five years, it will enjoy a 4.4% annualized expansion of its earnings multiple. Given also its 4.9% forward dividend yield, we believe the stock can offer a 19.4% average annual return over the next five years.
Supermajor Big Oil Stock #2: Exxon Mobil (XOM)
- Expected Returns: 17.4%
Exxon Mobil is an integrated super-major, with operations across the oil and gas industry. In 2019, the oil major generated over 80% of its earnings from its upstream segment, with the remainder from its downstream (mostly refining) segment and its chemicals segment.
Exxon Mobil is on the list of Dividend Aristocrats, a group of stocks with 25+ consecutive years of dividend increases.
There are currently 65 Dividend Aristocrats. You can download an Excel spreadsheet of all 65 (with metrics that matter such as dividend yields and price-to-earnings ratios) by clicking the link below:
In late July, Exxon reported (7/31/20) financial results for the second quarter of 2020. Due to the impact of the pandemic on the global demand for refined products, the oil major reduced its oil and gas production by 3% and 12%, respectively, over the prior year’s quarter, for a 7% total decrease. Moreover, the average realized prices of oil and gas plunged while Exxon ran its refineries at only 70% of their capacity. It thus switched from an adjusted profit of $0.61 per share to an adjusted loss of -$0.70 per share.
Exxon is currently facing a perfect storm due to the pandemic and its already lackluster performance even before the onset of the pandemic. In the last several quarters, the downstream and chemical segments have been suffering from depressed margins. These two segments used to provide a strong buffer to the results of the oil giant during downturns but they have failed to do so in the ongoing downturn.
Due to the poor results of Exxon for several quarters in a row and the impact of the coronavirus on its business, the stock has plunged near a 20-year low level. Consequently, the stock was recently expelled from the Dow Jones, after 92 years of continuous presence in the index.
Moreover, there has been increased speculation that Exxon will be forced to cut its dividend in the upcoming months due to a huge deficit in its cash flows in the near term. It has been reported that Exxon is likely to face a $48 billion deficit in its cash flows until the end of 2021 while its stock options that expire next year have already priced an approximate 50% dividend cut in the next 12 months. We believe that the dividend of Exxon is at the risk of being cut, particularly if the downturn caused by the pandemic lasts longer than anticipated.
On the other hand, we remain positive regarding Exxon’s long-term growth prospects. Global demand for oil and gas is likely to come close to last year’s level in 2021 and thus return to its multi-year growth trajectory. Moreover, Exxon has greatly increased its capital expenses in recent years in order to grow its production from 4.0 to 5.0 million barrels per day by 2025.
The Permian Basin will be a major growth driver, as the oil giant has about 10 billion barrels of oil equivalent in the area and expects to reach production of more than 1.0 million barrels per day in the area by 2024. Guyana, one of the most exciting growth projects in the energy sector, will be another major growth driver.
Source: Investor Presentation
Since 2019, Exxon Mobil has made 6 major deep-water discoveries in Guyana and has an enviable 89% success rate, with 16 discoveries out of 18 drilled wells. Exxon has started Liza Phase I ahead of schedule. Guyana’s total recoverable resources are estimated at over 8 billion oil equivalent barrels.
Thanks to its promising growth potential, we expect Exxon to grow its earnings per share by 8.0% per year on average over the next five years off their mid-cycle level (5-year average) of $3.26. The stock is currently trading at 11.0 times its mid-cycle earnings while our fair value estimate is an earnings multiple of 13. Expansion of the price-to-earnings multiple could boost annual returns by 3.3% per year. Given also its 9.7% dividend yield and 8.0% annual earnings growth, Exxon is likely to offer a 17.4% average annual return over the next five years.
Supermajor Big Oil Stock #3: BP plc (BP)
- Expected Returns: 17.0%
BP has gone through extreme challenges since its major accident in 2010. It has paid $67 billion for this accident so far. This amount is almost equal to all its earnings since. Even in 2019, nine years after the accident, BP paid $2.4 billion (24% of its earnings) for it. The company expects to pay $1.5 billion this year.
BP has greatly improved its portfolio via the addition of low-cost reserves and has markedly increased its production in recent years. Since 2016, it has brought 23 major projects online and has another 12 major projects until the end of 2021. Thanks to the ramp-up in projects, the company expects to add 0.9 million barrels per day to its production base from 2018 until the end of 2021. The new reserves have 35% greater cash margins and 20% lower development cost than base reserves.
Moreover, as BP drastically reduced its operating expenses in the previous downturn (2014-2016) and now invests only in projects that are profitable below $40 per barrel, it has reduced its breakeven point to $50 and expects to further reduce it to $35-$40 by 2021. We expect BP to grow its earnings per share by 9.0% per year on average over the next five years off their mid-cycle level (4-year average) of $2.00.
However, in 2019, the company posted a disappointing organic reserve replacement ratio of 67% and an actual ratio of 57%, which includes asset sales. Moreover, BP is now facing a strong headwind due to the impact of the pandemic on the energy market.
In early August, BP reported (8/4/20) financial results for the second quarter of 2020. During the quarter, oil temporarily plunged to a 20-year low while the average U.S. natural gas price was $1.70, the lowest level in 25 years, and refinery utilization slumped to 70%.
Source: Investor Presentation
Given also a 3.3% decline in production, BP switched from an adjusted profit of $2.8 billion in last year’s quarter to a loss of -$6.7 billion.
BP was caught in the current fierce downturn with a huge debt load. The oil major defended its dividend in the previous downturn of the energy market but slashed its dividend by 50% in the third quarter due to its leveraged balance sheet and the material losses expected this year.
Despite its recent dividend cut, BP is still offering an attractive forward dividend yield of 6.3%. This dividend can be considered safe, particularly given the extremely shareholder-friendly profile of the management of the oil major. Moreover, the stock is trading at 10 times its mid-cycle earnings, below our fair value estimate of 12.0.
If the stock reaches our fair valuation level over the next five years, it will enjoy a 3.7% annualized expansion of its valuation level. The combination of 9% expected earnings-per-share growth, a 6.3% dividend, and a 3.7% annualized multiple expansion results in expected annual returns of 17.0% per year through 2025.
Supermajor Big Oil Stock #4: Total (TOT)
- Expected Returns: 15.2%
Total is the fourth-largest oil and gas company in the world based on market capitalization. Like the other oil and gas super majors, it is a fully integrated company. Total operates in four segments: upstream, downstream (mostly refining), marketing & services and gas, renewables & power.
In late July, Total reported (7/30/20) financial results for the second quarter of 2020. Due to the coronavirus crisis, the average price of Brent plunged to $30 and European gas prices slumped to historic lows. In addition, Total curtailed its production by 3% due to the production cuts implemented by OPEC. Nevertheless, Total managed to post a marginal profit of $0.02 per share in the quarter.
Total was the only oil major, along with Royal Dutch Shell, which posted a profit in the second quarter, while the other peers posted material losses. Total thus proved once again that it is the most resilient oil major during downturns thanks to its integrated business model. Its Gas, Renewables & Power division grew its operating profit 21% in the first half of the year and thus provided a strong support to the results of the company amid the severe downturn caused by the pandemic.
It is also remarkable that Total has greatly improved the quality of its asset portfolio and its resilience since the previous downturn of the energy sector, in 2014. It has reduced its operating cost by nearly 50% and its cash breakeven point from more than $100 to $25 per barrel.
Source: Investor Presentation
This is an admirable achievement, particularly given that Total had already proved by far the most resilient oil major in the downturn of the energy market between 2014 and 2016.
Thanks to a $1.0 billion increase in cash flows that have resulted from strong LNG production growth, Total’s organic pre-dividend breakeven is below $25 per barrel while its organic post-dividend breakeven is below $50 per barrel. This is in sharp contrast to Royal Dutch Shell and BP, which cut their dividends this year.
While the 7.9% dividend of Total will not be absolutely safe in the event of a prolonged pandemic, the unparalleled resilience of Total renders its dividend exceptionally attractive for investors focused on the energy sector. U.S. investors should note they may be subject to dividend withholding taxes as Total is based in France.
We expect 7% annual earnings-per-share growth through 2025 off their mid-cycle level of $3.65 (5-year average) thanks to strong production growth and more favorable commodity prices after the pandemic subsides.
In addition to 7% expected earnings growth, Total is trading at 10.4 times its mid-cycle earnings, below our fair value estimate of 12. If the stock reaches our fair valuation level in five years, it will enjoy a 2.9% annualized expansion of its earnings multiple. Combined with the 7.9% dividend, we expect 15.2% annual returns through 2025.
Supermajor Big Oil Stock #5: Chevron (CVX)
- Expected Returns: 15.1%
Chevron is the second-largest U.S.-based oil company, behind Exxon Mobil. And like Exxon, Chevron is on the list of Dividend Aristocrats.
Last year, Chevron generated 78% of its earnings from its upstream segment. In addition, Chevron produces oil and natural gas at a 61/39 ratio but a portion of its gas output is priced based on the oil price. As a result, about 75% of the production of Chevron is priced based on the oil price.
In late July, Chevron reported (7/31/20) financial results for the second quarter of 2020. Due to the impact of the pandemic on the demand for oil products, Chevron reduced its production by 3% over the prior year’s quarter while its average realized oil price plunged 65%, from $57 to $20. As a result, the oil major switched from a profit of $1.77 per share to a loss of -$1.59 per share.
Chevron grew its output by 5% in 2017, 7% in 2018 and 4% in 2019 and expected to grow its output by 3%-4% per year over the next four years until recently. However, the pandemic has disrupted the growth trajectory this year.
Nevertheless, we believe that the sustained growth in the Permian Basin and in Australia will help the oil major return to growth mode from next year. It is remarkable that Chevron has more than doubled the value of its assets in Permian in the last two years, thanks to new discoveries and technological advances. In the absence of new lockdowns, the global oil demand is expected to retrieve nearly all its losses next year and rise to about 99 million barrels per day. As a result, Chevron is likely to resume growing its production from next year.
Moreover, Chevron now invests most of its funds on projects that begin delivering cash flows within two years. We expect the company to grow its earnings-per-share by about 13% per year on average over the next five years off its mid-cycle level (4-year average) of $4.36.
As a commodity producer, Chevron is vulnerable to any downturn in the price of oil, particularly given that it is the second most sensitive oil major (behind Eni) to the oil price. It is thus vulnerable to the ongoing downturn caused by the pandemic.
On the bright side, Chevron has the strongest balance sheet in its peer group and one of the lowest dividend breakeven points, at an oil price of $55 per barrel.
Source: Investor Presentation
These features are paramount during the ongoing downturn, particularly given the uncertainty regarding the duration of the effect of the pandemic on the energy market.
The stock of Chevron is currently trading at 17.4 times its mid-cycle earnings per share of $4.36. Our fair value estimate is a price-to-earnings ratio of 15.8. If the stock reaches our fair value estimate over the next five years, it will incur a 1.9% annualized contraction of its valuation level.
On the other hand, due to its suppressed stock price, Chevron is now offering a 6.8% dividend yield. The dividend is under pressure right now but management is confident that it can protect the dividend at the prevailing oil prices thanks to the strong balance sheet, a reduction in capital expenses and the suspension of share repurchases.
With a 6.8% dividend yield, future expected earnings-per-share growth of 13% per year, and a negative 1.9% annual contraction of its earnings multiple, we expect total annual returns of 15.1% per year through 2025.
Supermajor Big Oil Stock #6: Eni (E)
- Expected Returns: 6.0%
Eni is a major oil and gas producer based in Italy. It has exploration activity in more than 40 countries. It operates in three segments: exploration & production, gas & power, and refining & marketing. Its upstream segment is by far the largest. In 2018 and 2019, this segment generated 92% and 93% of total operating income, respectively. This is a major difference between Eni and the other energy super majors; Eni’s business is much less diversified.
In late July, Eni reported (7/30/20) financial results for the second quarter of 2020. The company reduced its production by 6.6% over the prior year’s quarter due to the pandemic and the resultant OPEC production cuts. In addition, the average realized price of oil of Eni plunged 58% and thus the company switched from a profit of €0.32 per share to a loss of -€0.40 per share.
Due to its nearly pure upstream nature, Eni is more vulnerable to the ongoing downturn than the other oil majors. It is also remarkable that Eni posted poor earnings even in the three quarters that preceded the pandemic due to lackluster oil and gas prices.
On the bright side, Eni expects to grow its output by approximately 3.5% per year on average until 2025.
Source: Investor Presentation
One of the growth drivers will be the ramp-up of the Zohr field in Egypt, the largest gas field in the Mediterranean, which holds about 30 trillion cubic feet of gas. Eni has a 50% stake in this field. Overall, we expect Eni to grow its earnings-per-share by 6.0% per year on average over the next five years off their mid-cycle level of $1.20.
Eni has about 7.2 billion barrels of oil equivalent in proved reserves, which are sufficient for 10.4 years of production given the current production rate of the company. The duration of its reserves is lower than the ~12-year duration of the reserves of certain peers.
In addition, Eni has a breakeven point of about $55 per barrel, excluding the dividend. This is much higher than the breakeven point of most oil majors, which have cut their expenses and reshaped their portfolios more drastically than Eni. For perspective, BP has already driven its pre-dividend breakeven point below $50 and aims to reduce it to $35-$40 by 2021. The high breakeven point of Eni helps explain its recent 70% dividend cut. Regarding the dividend, U.S. investors should note that they may be responsible for dividend withholding taxes because Eni is based in Italy.
Eni stock is currently trading at 15.0 times its mid-cycle earnings, above our fair value estimate of 12.5. If the stock reverts to our fair valuation level in five years, it will incur a 4.4% annualized drag in its returns. Given the expected earnings multiple contraction, 6% annual earnings-per-share growth and the 3.2% dividend yield, the stock is likely to offer a total return of 6.0% per year over the next five years.
The recent plunge in oil prices, combined with fears of a coming recession, have caused oil stocks to decline significantly in recent weeks. As a result, this has compressed valuations and elevated dividend yields across the energy sector.
Of course, there is no guarantee the high levels of expected returns will materialize. A prolonged recession could derail these companies’ growth prospects, and could result in dividend cuts. As a result, only investors with a long-term focus and a high tolerance for risk should consider investing in oil stocks.
Meanwhile, Exxon Mobil is arguably the most conservatively run company, with the strongest balance sheet of the group. It has the highest credit rating of the oil majors, and has increased its dividend each year for over 30 years (as has Chevron).
On the other hand, Royal Dutch Shell seems to have the potential to offer the highest 5-year return. It possesses the strongest combination of an undervalued share price, future EPS growth potential, and a high dividend yield.
All of the Big Oil stocks on this list are expected to generate attractive returns to shareholders through 2025. This makes all six potentially attractive picks for investors, particularly those looking for income and value.