Investors looking for a reliable dividend from an oil company could be forgiven for looking no further than Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US).
Shell is the largest company in the FTSE 100 and its 6.4% prospective yield is a big temptation. Dividend yield is only half the story, though. Long-term holders need to think about dividend growth, and Shell’s record in this department is a bit patchy.
The firm’s dividend was flat from 2009-2011, since when it has risen by 11.9% to $1.88 per share. However, this rate of growth may not continue, thanks to Shell’s blockbuster £47bn bid for BG Group, which could cramp Shell’s ability to increase its payout.
In the BG offer document, Shell said that the current $1.88 dividend would be maintained in 2015 and maintained or increased in 2016. In my view, that sounds like dividend growth will take second place to the costly process of integrating BG into Shell.
As a result, I reckon it might be worth considering income alternatives elsewhere in the oil sector.
What about Soco?
One possibility is SOCO International (LSE: SIA). In a trading update on Wednesday, Soco confirmed its intention of paying a dividend of 10p per share in 2015, giving a yield of 5.4%.
What caught my eye, however, was the suggestion that in the face of persistent lower oil prices, the firm might shift its focus from costly exploration towards shareholder returns.
Soco said that it is “reviewing options to maximise value from its Africa portfolio” including a sale or farm-out of its assets in the region, most of which are in the appraisal and development stage, with no production.
Soco’s Vietnamese production assets are very low cost. The firm says that in terms of operating cash flow, they break even in the “low $20s” per barrel. This means that whatever happens to the price of oil, Soco’s Vietnamese production should continue to generate plenty of surplus cash.
Although some of this will have to be reinvested to maintain and increase production, the rest can potentially be returned to shareholders. The firm’s current strategy, outlined in last year’s results, is to return 50% of free cash flow to shareholders.
Soco has already identified cost cuts of 10% to operational and capital expenditure, and is targeting further cuts. If the firm also manages to sell Africa and avoid new exploration projects for a while, then I believe Soco should continue to generate surplus cash.
Soco will be left with net cash of $101m after has paid the 10p per share dividend, which equates to a total payout of $50m. To put that into context, last year, Soco’s free cash flow was $119m.
Although that figure is going to fall dramatically in 2015, I’d expect it to start to recover in 2016, as cost-cutting and reduced exploration expenditure feeds through to profits.
I think that Soco could prove to be a profitable income play over the next few years, with the potential for significant gains if oil manages to rise above $70 per barrel again.
Ultimately, it depends on your circumstances. Soco’s cash returns could be very profitable, but are unlikely to be as regular as Shell’s quarterly dividends.
