Let's Drill Down on These 2 Energy Dividend Names

After many years of underperformance, the energy sector has become the top performer of the S&P 500 this year. This is because of the rally in oil prices to a nearly seven-year high, thanks to the ongoing recovery of global oil demand from the pandemic, and the deep production cuts of OPEC and Russia. Many quality oil stocks can still be bought for high dividend yields and strong total returns. In this article, we will compare the prospects of two Dividend Aristocrats, Exxon Mobil and Chevron . Exxon: Big Energy Exxon Mobil is the largest oil and gas company in the world, with a market capitalization of $258 billion. It produces oil and natural gas at a 60/40 ratio and it is one of the most integrated oil majors, with significant contribution from its refining and chemicals segments. Thanks to its integrated business model, Exxon used to be the most defensive oil major to recessions. However, the company faced a perfect storm last year due to the coronavirus crisis, which caused a collapse in the price of oil as well as in the margins of refining and chemicals segments. As a result, the oil giant incurred its first loss in more than a decade last year. But all the segments of Exxon are recovering strongly from the pandemic this year. According to the latest report of the Energy Information Administration (EIA), global oil consumption is expected to surge from 92.4 million barrels per day in 2020 to 97.4 million barrels per day in 2021 and the pre-pandemic level of 101.0 million barrels per day in 2022. This positive trend has already shown up in the results of Exxon. In the second quarter, its upstream segment thrived thanks to the rally of the oil price while its chemicals segment posted record earnings of $2.3 billion, thanks to pent-up demand after the pandemic and high margins. As a result, the company switched from an adjusted loss per share of $0.70 in last year's quarter to a profit per share of $1.10. Even better, the rally of the prices of oil and gas has continued since the end of the second quarter, thanks to strong pent-up demand and limited supply. As a result, Exxon recently provided rosy preliminary guidance for the third quarter. It expects the higher oil and gas prices to boost its earnings by $200 million to $600 million and $500 million to $900 million, respectively. Given this guidance, Exxon is likely to post its highest quarterly earnings per share in seven years for the third quarter. Chevron Revs Up Chevron is the third-largest oil major in the world, based on its market capitalization of $202 billion, behind only Exxon and Royal Dutch Shell (RDS.B). Chevron is more leveraged to the oil price, with a 61/39 production ratio. Moreover, as it prices a portion of its natural gas volumes based on the oil price, about 75% of its total output is priced based on the oil price. Chevron has drastically improved its asset portfolio in the last five years, with the addition of low-cost, high-margin barrels and the divestment of low-return assets. As a result, it posted free cash flows of $5.6 billion last year, during one of the fiercest downturns in the history of the energy sector. As a result, it is poised to achieve nearly seven-year high earnings per share this year. Growth Prospects Exxon is the only oil major that has failed to grow its production over the last 13 years. The company currently has two major growth drivers, its projects offshore Guyana and in the Permian Basin. Guyana is one of the most exciting projects in the oil industry. Exxon has nearly tripled its reserves in the area, from 3.2 billion barrels in early 2018 to nearly 9.0 billion barrels now. Exxon also expects to increase its output in the Permian Basin, from 400,000 barrels per day this year to 700,000 barrels per day in 2025. However, Exxon has indefinitely postponed other growth projects, such as the $30 billion Mozambique LNG export project, in order to preserve funds and defend its generous dividend. Consequently, the natural decline of its fields will offset the additional volumes from the above two growth projects. Management now expects to maintain flat output for at least another four years. As a result, we expect Exxon to up its earnings per share by only 2.0% per year on average over the next five years. On the contrary, Chevron has been growing its production consistently in recent years. It increased its production by 5% per year on average in 2017-2019. Even last year, when most oil producers cut their production due to the pandemic, Chevron grew its output 1%, assisted by its acquisition of Noble Energy, which enhanced the presence of Chevron in the Permian Basin. Chevron has also outperformed its peers by a wide margin in the replenishment of its reserves. During the last five years, Chevron has posted a reserve replacement ratio of 99%, which is much higher than the average metric of its peers, whose reserves have declined in recent years due to asset sales and the natural decline of their fields. Overall, we expect Chevron to grow its earnings per share at a 4.0% average annual rate over the next five years. Dividend Safety Exxon and Chevron are the only two Dividend Aristocrats in the oil industry, with 38 and 34 consecutive years of dividend growth, respectively. Exxon is currently offering a 5.6% dividend yield, which is higher than the 5.1% dividend yield of Chevron. Both companies have payout ratios of 74%, based on their expected earnings this year. However, Chevron has much more promising growth prospects and, therefore, it is likely to raise its dividend at a faster pace than Exxon is in the upcoming years. It is also remarkable that Chevron raised its dividend by 8% last year and 4% this year, despite the pandemic. On the contrary, Exxon has paid the same dividend for 10 consecutive quarters, signaling that it is struggling to maintain its dividend. Moreover, Chevron enjoys much stronger free cash flows than Exxon thanks to its low-cost reserves. The former posted free cash flows of $5.6 billion last year, whereas Exxon posted negative free cash flows of $1.3 billion. Chevron also recently stated that its dividend is safe, even if Brent prices are $40 (50% lower than the current price). In such an adverse scenario, Chevron expects to cover its dividend with the assistance of a low amount of debt. At oil prices around $60, the oil major expects to achieve free cash flows in excess of $25 billion over the next five years. Exxon is offering a somewhat higher dividend yield than Chevron but the dividend of the latter has a much wider margin of safety. Valuation & Expected Returns Exxon and Chevron are highly cyclical and as a result, their valuations have fluctuated wildly over the past decade. Their price-to-earnings ratios greatly increase during periods of depressed earnings, whereas they decrease during boom periods. Based on its expected earnings per share of $4.70 this year, Exxon is currently trading at a price-to-earnings ratio of 13.2, which is only slightly higher than our assumed fair price-to-earnings ratio of 13.0 of the stock. If the stock trades at its fair valuation level in five years, it will incur a marginal 0.3% annualized drag in its returns over the next five years. Given the 2.0% annual earnings-per-share growth and the 5.6% dividend, Exxon is likely to offer a 6.6% average annual return over the next five years. And the Best Bet Is ... Based on its expected earnings per share of $7.30 this year, Chevron is currently trading at a price-to-earnings ratio of 14.4, which is slightly higher than our assumed fair price-to-earnings ratio of 14.0 of the stock. If the stock trades at its fair valuation level in five years, it will incur a marginal 0.5% annualized drag in its returns over the next five years. Given also the 4.0% annual earnings-per-share growth and the 5.1% dividend, Chevron is likely to offer a 7.6% average annual return over the next five years. Exxon and Chevron are recovering strongly from the pandemic this year, primarily thanks to the rally of the prices of oil and gas to nearly seven-year high levels. Exxon is offering a 5.6% dividend, which is higher than the 5.1% dividend of Chevron. However, Exxon has failed to grow its production over the last 13 years and expects flat output for at least four more years. Chevron has much more promising growth potential. As it is also more resilient than Exxon in the event of lower oil prices, it is offering a much safer dividend. Given also superior expected five-year return, Chevron appears more attractive than Exxon right now.

Let's Drill Down on These 2 Energy Dividend Names

Here we'll compare oil stocks: Exxon Mobil vs. Chevron.

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