The energy stocks in the

S&P 500

have lost about half their value this year. The sector is littered with dividend cuts and suspensions, as companies have moved to shore up cash positions amid the pandemic and weaker oil prices. This isn’t the ideal scenario for income investors.

And yet.

“There are selective opportunities across the energy sector to find sustainable and attractive income,” Devin McDermott, head of North American oil and gas research at Morgan Stanley, tells Barron’s.

Among the dividend-paying energy companies that McDermott favors are

Chevron

(ticker: CVX) and an assortment of midstream operations, which typically focus on infrastructure, such as pipelines to transport oil and gas. Those include

Magellan Midstream Partners

(MMP) and

Enterprise Products Partners

(EPD), both of which are master-limited partnerships—popular income vehicles, at times. Those two MLPs were recently yielding 11.8% and 11%, respectively.

McDermott also likes the dividend outlook for

Williams Cos.

(WMB), whose assets include pipelines for transporting oil and gas. It recently yielded 7.9%.

“Those [stocks] all have fairly compelling dividend yields that are sustainable, even in this new normal, and they all have strong balance sheets to give then flexibility through this cycle,” McDermott says, referring in part to weak commodity prices and margins for potentially an extended period.

But investors should use caution. Among energy companies in the S&P 500 alone, exploration-and-production firms

Apache

(APA),

Occidental Petroleum

(OXY), and

Noble Energy

(NBL) have slashed their payouts this year. Another E&P firm,

Marathon Oil

(MRO), suspended its dividend.

Global oil companies haven’t been immune to cuts, either.

BP

(BP.London) said in August that it would halve its quarterly dividend to 5.25 cents a share from 10.5 cents. And

Royal Dutch Shell

(RDS.A) in April slashed its payout by about two-thirds, to 16 cents a share.

Prices as of the close on Sept. 28; yields as of Sept. 29.

Source: FactSet

The two integrated oil companies included in the table—

Exxon Mobil

(XOM) and Chevron—have maintained their quarterly disbursements during the pandemic, but their underlying stories are different.

For Exxon Mobil, which has been using debt to pay its dividend, there has been much speculation about how safe the payout is. Exxon Mobil common stock is yielding 10.2%. It’s down about 45% this year, dividends included.

“In a world where this is the new normal—lower for longer commodity prices and weak margins across its downstream [businesses]—that dividend will not stand over the longer term, and ultimately they will have to make a decision,” McDermott warns.

Using debt to pay a dividend is an unsustainable long-term strategy, he says. And oil prices remain depressed, with Brent crude a little below $42 a barrel recently—versus the high $60s late last year.

Still, Exxon has been steadfast in keeping the dividends coming. In late July, it declared a quarterly disbursement of 87 cents a share, in line with earlier payouts.

The company has even kept its status as an S&P 500 Dividend Aristocrat, increasing its payout for 37 consecutive years, by virtue of maintaining its dividend this year. Even if doesn’t raise its payout this year, it will remain in the group because its total paid in 2020 would exceed last year’s level, assuming there is no cut through year’s end.

A company spokesman, asked for comment, referred Barron’s to remarks made by Senior Vice President Neil Chapman during a second-quarter earnings call with analysts on July 31. Exxon Mobil, he said, had cut short-term capital spending by more than 30% and was on a pace to reduce cash operating expenses by more than 15%.

“A large portion of our shareholder base has come to view that dividend as a source of stability in their income, and we take that very seriously,” Chapman said. “Our plans to maintain our debt at the current levels and maintain our dividend include further reductions in operating expenses.”

Wells Fargo Securities analysts Roger Read and Lauren Hendrix, in a recent research note, expressed optimism that the company could sustain its payouts. “Contrary to some, we believe [Exxon Mobil] can maintain its current dividend payout through 2023, absent another oil price collapse,” Read and Hendrix wrote, adding that “to restore faith [Exxon Mobil] must pursue real strategic changes and go beyond short-term capex cuts.”

Chevron, meanwhile, yields 7.2%—still high, but not to the level that investors are doubting its ability to pay the dividend.

“In the current $40 oil world, the dividend is covered on a forward-looking basis, and the balance sheet is in excellent shape,” McDermott says. “Of all the global oil majors, Chevron has the best balance sheet and the lowest leverage, and that gives them additional flexibility through this period of uncertainty.”

McDermott calculates that Exxon Mobil, in contrast, will require an average Brent price of $60 a barrel over the next five years to cover its dividend. Unlike Chevron, Exxon Mobil was more aggressive in its capital spending to spur growth “to position themselves better than peers in a commodity recovery,” McDermott says.

Aware of its need for belt-tightening, Exxon Mobil is now on a pace for about $19 billion a year in capital spending, down from around $30 billion to $35 billion in previous years, McDermott observes.

“The company is doing the right things. They are managing what’s in their control, but unfortunately this commodity price environment is out of their control,” he adds.

And therein lies the wild card for income investors: Even the most stalwart and disciplined dividend payers in the energy patch might be committed to their payouts, but the pandemic could have other plans.

Write to Lawrence C. Strauss at [email protected]

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