Valuentum Exclusive Analysis for the Discerning Investor

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Jan 11, 2021

Energy Sector In Shambles, Looks to Recover But Headwinds Persist
Image Source: ConocoPhillips – November 2019 Analyst and Investor Meeting IR Presentation. Though raw energy resource pricing is on the rebound, the outlook for the oil and gas industry remains stressed. Global demand for oil and related refined petroleum products remains subdued due to headwinds generated by the ongoing coronavirus (‘COVID-19’) pandemic. The OPEC+ oil cartel has responded by pledging to keep a significant amount of oil output off the market for an extended time. However, raw energy resource prices need to go much higher and be sustained at elevated levels before the space could become attractive from a longer-term perspective. In our view, the US upstream industry (specifically those in the shale patch) need WTI to move and stay north of $60 per barrel to be in a position to generate meaningful free cash flow while also investing enough to maintain their production bases. We think the dividends at the oil majors may be at risk, even Exxon’s, and we include two high-risk midstream stocks in the High Yield Dividend Newsletter portfolio to capture a relatively benign risk-reward scenario when it comes to their respective yields. We maintain a cautious view on the MLP business model, more generally, however. For now, we are keeping a close eye on the energy sector considering things are slowly moving in the right direction. However, given the collapse in raw energy resources pricing witnessed during the first half of 2020, the industry still has a long way to go before it is out of the woods, so to speak.

Nov 17, 2020

Chevron’s Forward-Looking Dividend Coverage is Becoming Stressed
Image Shown: Chevron Corporation reduced its capital expenditure expectations a couple of times this year, though that still has not enabled the firm to generate meaningful free cash flows given the various headwinds facing its businesses. Image Source: Chevron Corporation – November 2020 IR Presentation. On October 30, Chevron Corp reported third quarter earnings for 2020. As expected, it was a brutal report from Chevron. The ongoing coronavirus (‘COVID-19’) pandemic decimated global energy demand and severely weakened raw energy resources pricing at a time when refining margins are quite weak. This double whammy saw Chevron post a $0.2 billion GAAP net loss in the third quarter of 2020 as its revenues tanked.

Nov 15, 2020

Exxon Mobil’s Weak Forward-Looking Dividend Coverage is Very Concerning
Image Source: Exxon Mobil Corporation – Third Quarter of 2020 IR Earnings Presentation. Exxon Mobil Corp has contended with enormous headwinds so far in 2020 due to the ongoing coronavirus (‘COVID-19’) pandemic, and that has put its dividend at risk. Over the past couple of years, the company has come nowhere close to generating enough free cash flow to cover its dividend obligations. Exxon Mobil’s forward-looking dividend coverage appears quite weak and the company is currently leaning heavily on debt markets to keep making good on those obligations. As of this writing, shares of XOM yield ~9.7% as investors are increasingly pricing in the chance for a meaningful payout cut.

Nov 4, 2020

Our Thoughts on Magellan Midstream’s Latest Earnings
Image Shown: Keeping the many headwinds facing the energy infrastructure space in mind, Magellan Midstream Partners LP remains one of our favorite midstream master limited partnerships. Image Source: Magellan Midstream Partners LP – October 2020 IR Presentation. On October 30, Magellan Midstream Partners reported third quarter 2020 earnings that beat both top- and bottom-line consensus estimates. The midstream master limited partnership (‘MLP’) space has faced enormous headwinds due to the ongoing coronavirus (‘COVID-19’) pandemic, though the firm was still able to generate sizable free cash flows during the first nine months of 2020. Magellan Midstream is a modestly-weighted holding in the High Yield Dividend Newsletter portfolio, and as of this writing, units of MMP yield ~11.1%. Though that yield is quite high, given that the firm’s free cash flows should grow significantly going forward, we are optimistic the firm will be able to continue making good on its payout obligations for the time being.

Nov 2, 2020

ICYMI -- Dividend Growth Strategies Struggle
Image: A large cap growth ETF (orange) has significantly outperformed an ETF tied to a dividend growth strategy, the SPDR S&P Dividend ETF (SDY), which mirrors the total return performance of the S&P High Yield Dividend Aristocrats Index. To no surprise to many members, several dividend growth strategies have faced tremendous pressure during 2020. The Journal recently wrote a piece on the topic, but from our perspective, the problem with many dividend growth strategies is that they tend to be balance-sheet agnostic and pay little attention to traditional free cash flow expectations, focusing only on the yield itself, sometimes dismissing future fundamentals in favor of historical growth trends and the inferior EPS-based dividend payout ratio. In many dividend-targeted ETFs, for example, it may not matter to the index creator whether a firm has $10 billion in net debt or $10 billion in net cash; as long as management has a track record of raising the dividend in the past, it is included. To us, however, there is a world of difference between a company that has a huge net cash position and a huge net debt position. The more excess cash on the balance sheet a dividend payer has, for example, the more secure its payout. In some cases, entities held in high-yielding ETFs don't even cover their dividends or distributions with traditional free cash flow generation, despite having ominous net debt loads. A look at the high-yielding ALPS Alerian MLP ETF, for example, shows a number of entities that are buried under a mountain of debt and are generating meager free cash flow relative to expected distributions. The lofty yield on that ETF should therefore be viewed with a very cautious eye. If the yield weren't at risk for a big cut, the market would bid up the stock, and down the yield would go. In no way should you believe that you can sleep well at night holding stocks yielding north of 10% when the current 10-year Treasury is well below 1%. The market is just not that inefficient. A dividend growth strategy can never be a passive one either. Only through constant attention to the balance sheet (net cash) and future free cash flow expectations can investors truly sleep well at night. At Valuentum, we do the balance sheet and cash flow work and summarize it succinctly in a key ratio called the Dividend Cushion ratio.

Oct 30, 2020

Dividend Increases/Decreases for the Week October 30
Let's take a look at companies that raised/lowered their dividend this week.

Oct 27, 2020

Energy Transfer’s Dividend Cut Not Enough, Needs to Slash It More
We expect another distribution cut from Energy Transfer in the not-too-distant future. Its traditional free cash flow generation is still too meager to cover its now-reduced distribution level, and the energy markets are simply not cooperating. The energy sector has been among the worst-performing equity sectors for some time now, and investor appetite for new equity and debt issuance is waning as return expectations are ratcheted down in a troubled energy resource environment. We expect more pain to come for Energy Transfer’s stock. Our fair value estimate stands at $4 per share.

Oct 20, 2020

ConocoPhillips Is Buying Concho Resources
Image Shown: An overview of the pro forma asset base of ConocoPhillips and Concho Resources Inc. Please note that Concho Resources’ main operations are in the Permian Basin in West Texas and Southeastern New Mexico, a region that ConocoPhillips seeks to grow its exposure to. ConocoPhillips has an expansive upstream portfolio with operations worldwide, though its North American position is set to become a much larger part of its company-wide profile. Image Source: ConocoPhillips – ConocoPhillips & Concho Resources Transaction Announcement IR Presentation. On October 19, ConocoPhillips announced it was acquiring Concho Resources through an all-stock deal. If the deal goes through as planned, each share of CXO will be exchanged for 1.46 shares of COP, and as the press release notes, this represents “a 15 percent premium to closing share prices on October 13.” However, please keep in mind shares of CXO have fallen by roughly two thirds since October 2018 as of this writing, indicating ConocoPhillips is really not paying much of a premium for Concho Resources.

Oct 15, 2020

Our Thoughts on the Potential Acquisition of Concho Resources by ConocoPhillips
Image Source: ConocoPhillips – November 2019 Annual & Investor Meeting Presentation. According to Bloomberg, the super-independent ConocoPhillips is currently talking with Concho Resources about acquiring the company. We do not expect that such a deal will come with a significant premium, and furthermore, and we expect that such a deal will likely be funded with equity. Our reasoning is underpinned by recent M&A activity in the oil patch, such as the all-stock acquisition of Noble Energy by Chevron Corporation through a ~$5 billion deal that was completed in early-October. That deal involved Chevron paying a ~12% premium (based on ten-day average closing stock prices) at the time of the announcement, though please note shares of Noble Energy had cratered beforehand indicating that Chevron did not have to pay up for the company. Noble Energy, like Concho Resources, also had a significant position in the Permian Basin (though its Mediterranean assets were Chevron’s main target, in our view). We covered that deal in great detail. As it concerns our view that ConocoPhillips would likely use equity instead of cash to acquire Concho Resources (should such a deal materialize), that is largely due to ConocoPhillips’ sizable net debt load at the end of June 2020 and its inability to generate meaningful free cash flows in the current pricing environment for raw energy resources. Additionally, Concho Resources had a net debt load at the end of June 2020 and is also unable to generate meaningful free cash flows in the current environment. The oil patch is contending with serious financial constraints and all-stock acquisitions/mergers with minimal premiums are likely going to continue being the norm for some time.

Oct 2, 2020

Our Thoughts on the Oil & Gas Industry
Image Shown: Crude oil prices, measured by the WTI benchmark, plummeted during the initial phases of the COVID-19 pandemic and have yet to fully recover. Declines in global crude oil prices have depressed prices for natural gas, natural gas liquids, and liquified natural gas as well. We expect that it will take some time for the oil and gas industry to truly recover, and hefty net debt loads combined with onerous dividend obligations are making that a very tough task. Juicy dividend yields are a sign of the headwinds facing the oil and gas industry and are not a sign of strong underlying strength in those firms that are paying out generous dividends. Most of the juicy dividend yields within the energy space are a sign of the stress facing those companies and the industry at-large, and we caution that the chance other oil majors follow Shell and BP in cutting their payout remains very likely. For instance, Exxon Mobil’s payout is simply not well-covered in the current raw energy resources pricing environment and the firm is taking on a lot of debt to cover those obligations. Chevron Corporation’s payout is also on shaky ground as it generated negative free cash flows during the first half of 2020 while carrying a large net debt load at the end of June, though like Exxon Mobil, Chevron’s management team has stuck with its current dividend policy so far. Like Shell, Chevron also grew its natural gas and LNG business meaningfully over the past few years, but that strategy did not pan out as intended.