For companies that pump out cash, dividends are a popular way to share some of it with their shareholders. But that cash-generation power may fluctuate, so many companies in the energy and resources sectors have been turning to variable dividend payments.
Here’s how it works: Companies pay a relatively low base dividend that they believe they can maintain throughout an economic cycle, plus a variable dividend based on their earnings that often involves a formula. This differs from special dividends, which are one-off events sometimes related to the sale of a business.
Variable dividends are playing well with investors. They have put a premium valuation on
(ticker: DVN) and
Pioneer Natural Resources
(PXD), both early adopters of the variable strategy that now boast yields of around 7% between their base and variable dividends.
(COP) is another practitioner, although its combined yield is lower, at 3%.
(FANG), a large exploration and production company, plans to roll out the structure in 2022.
Energy variable dividends should be headed higher in 2022 thanks to a rally in oil prices, which hit $82 a barrel this past week and could be headed for $100.
And if oil bulls like Goldman Sachs’ commodity analyst Jeff Currie are right about an energy supercycle this decade, it could be a good 10 years for dividends.
Outside of energy,
(NEM), the top gold miner, has a similar dividend approach and now yields close to 4% between its base and variable payouts.
(FCX), the leading global copper miner, has announced a dual dividend, although its yield is now modest, at 1.3%.
(AGCO), the farm-equipment maker, pays a base dividend of just 0.6%, but is supplementing that with an annual special dividend keyed to earnings that has boosted its total dividend yield to 4%.
The resource sector is well positioned to pay more dividends because balance sheets are in their best shape in decades and profits are ample.
“The mining industry is very focused on capital returns,” explains Chris LaFemina, a Jefferies analyst. “With balance sheets generally repaired, there will be substantial capital returns. The only debate is the structure.”
(OMF) is a rare financial company that has pursued a version of the base/variable strategy. It makes consumer installment loans at 20%-plus interest rates to below-prime customers, generating lofty returns. It has been paying big variable semiannual dividends the past two years. The base dividend is $2.80 a share annually, and OneMain has paid out $6.75 a share in variable dividends in the past 12 months, or a total of $9.55, for a trailing yield of 17% at its recent stock price of $55.
“Investors like that the company is optimizing its capital structure while getting a good dividend yield,” says John Hecht, a Jefferies analyst who has a Buy rating and a $70 price target on the stock.
Variable dividends aren’t for everyone, but they can be a good way for companies to maintain financial discipline and return cash when many investors are hungry for income.
One fan of the strategy is David King, a manager of the Columbia Flexible Capital Income fund. “I’m really high on companies with formulaic special dividends,” he says. “They’re not well understood by the market.” Funds he manages own OneMain, Pioneer, and the insurer
(PGR), which has paid excess capital in a special dividend in recent years.
|Company / Ticker||Recent Price||52-Week Chg||2022E EPS||2022E P/E||Base Div*||Variable Div*||Total Div Yield|
|OneMain Holdings / OMF||$54.49||5.8%||$8.81||6.2||$2.80||$6.75||17.5%|
|Pioneer Natural Resources / PXD||204.91||51.7||20.10||10.2||2.24||12.08||7.0|
|Devon Energy / DVN||49.90||153.2||5.39||9.3||0.44||2.92||6.7|
|Newmont / NEM||61.52||-1.6||3.10||19.9||1.00||1.20||3.6|
|ConocoPhillips / COP||84.40||78.0||7.93||10.6||1.84||0.80||3.1|
|Freeport-McMoRan / FCX||45.15||45.7||3.54||12.7||0.30||0.30||1.3|
Sources: Bloomberg; company reports
The variable dividend approach differs from the one taken by
(CVX), which pay relatively high base dividends and seek to maintain them throughout the cycle. Exxon, which yields 5%, and Chevron, with a 4.2% yield, had to take on debt to pay their dividends during the pandemic when energy prices crashed. They are now in a position to raise them, given the strength in oil and gas.
Devon was the first sizable energy company to move to variable dividend format a year ago. The company pays a modest base dividend of 44 cents annually, for a yield of less than 1% with a stock price at $49. It also paid a 73-cent variable dividend in the fourth quarter based on a formula of up to 50% of its excess free cash flow. Devon’s total 2022 dividend could hit $4 a share, up from the annualized $3.36 in the fourth quarter.
“We’re responding to what our investors want,” says Devon CEO Rick Muncrief. “They’re saying: ‘We don’t want production growth, and we want to see capital coming back to us primarily through dividends rather than stock buybacks.’ ” Investors like the clarity of the formula, he adds.
Resource companies are prime candidates for variable dividends because of the volatility of their earnings.
(NUE), the industry leader, ought to consider them as a complement to stock buybacks. Nucor, whose shares trade around $110, pays a dividend of $2 annually. With its ample profits, Nucor favors stock repurchases, buying back more than $3 billion of stock in 2021 while paying $600 million in dividends.
“We think our stock is undervalued and that we create more value for shareholders by buying back stock” than paying a higher dividend, says Jim Frias, Nucor’s chief financial officer.
(GOLD), the No. 2 gold miner, faces investor pressure to unveil a variable dividend to match Newmont’s. Barrick is expected to reveal its decision next month, when it reports quarterly earnings. Newmont, whose shares trade around $60, pays a base dividend of $1 a share and a variable one linked to gold prices, which is now $1.20 a year.
LaFemina of Jefferies thinks that
(RIO), two of the world’s largest iron-ore producers, should adopt a base/variable dividend structure rather than their current variable payouts, which resulted in big yields last year.
“A 4% base dividend is very doable for them,” he says, adding it would support their stock prices when iron-ore prices are low. Both have little or no net debt on their balance sheets.
Outside of energy and resources, who else could be a candidate?
), the nation’s largest bank. JPMorgan CEO Jamie Dimon has questioned the wisdom of share buybacks at elevated stock prices, saying three years ago that it would be “crazy” to buy back stock at three times tangible book value.
With its stock rallying in the past year to a recent $160, the bank trades for around 2.3 times tangible book value. Its base dividend is now $4 a share a year, or a 2.5% yield and a third of projected 2022 earnings.
Columbia’s King, a longtime holder of JPMorgan, says: “A disciplined or formulaic special dividend would be an interesting idea for them to consider. The accounting and regulatory optics of share buybacks at a high multiple to tangible book aren’t good.”
JPMorgan declined to comment.
Corporate executives in general may be loath to scale back stock buybacks because of what it could signal about their share prices. Variable dividends, nonetheless, are likely to catch on and provide investors more opportunities for income.
Write to Andrew Bary at [email protected]