FTSE 100 oil companies BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have shown decent recovery in the past year. Initially it was the hope of economic recovery driving up prices from late November, as the first vaccines were developed. Oil prices started rising around the same time, but reached levels that would make oil companies profitable only by early this year. As these companies reported healthy profits, they started paying out dividends again as well.
Present dividend yields are underwhelming
At present, BP’s dividend yield is around 5%, while Shell’s is 3.7%. On the face of it, at these yields, the title may sound confusing. I mean, these are hardly the highest dividend yields around. The average FTSE 100 yield right now is some 3.5%. Shell is actually hovering around that number, which, if anything, makes it an average dividend yield stock. BP is doing slightly better. But in no way is it comparable to miner and steel producer Evraz, which has the highest yield of 12.5%.
But what if dividends go back to pre-pandemic levels?
If I consider both the past and potential future for these stocks, however, they are significantly better placed than many other FTSE 100 stocks. First, let us consider where they were before the corona crisis began. In early 2020, both had double-digit dividend yields, which makes them comparable to the highest right now. Their dividend amounts are also way lower than they were pre-pandemic. This gives me hope that further increases in their dividends can happen. Incidentally, it can push up their share prices too.
Future’s bright for oil stocks
Moreover, the outlook for the medium-term, which is to say the next three to five years, also looks good for these stocks. Crude oil prices have picked up pace in 2021 compared to last year, in any case. Only a slight decline is expected next year. Considering that the economy has picked up pace and travel demand is expected to rise further, I reckon a small decline in oil prices next year will not impact these stocks.
Both BP and Shell should continue to be in a comfortable place in the foreseeable future. But the same cannot be said for other commodity stocks that offer higher dividends. Industrial metal miners have had a great past year because of China’s fiscal stimulus. But if this slows down, there is a risk to their prices. A strong economy should stave off a crash, but a softening could happen. Similarly, FTSE 100 real estate stocks’ dividends are at risk as a housing market softening could happen as well.
Protection from inflation
Other companies’ dividends can also be impacted if inflation continues to rise. If companies are unable to pass on the costs, their profits will shrink. And if they do pass on costs to consumers, they run the risk of lower demand. Oil stocks, on the other hand, are on the right side of inflation. Rising oil prices are one of the reasons why costs are getting pushed up. So these stocks are good buys as inflation increases too. For these reasons, I already hold them in my portfolio.
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Manika Premsingh owns shares of BP and Royal Dutch Shell B. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.