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A High Yield Oil & Gas Portfolio
Posted by: Fede Zaldua (IP Logged)
Date: December 20, 2013 05:13PM

Even when the Federal Reserve has already decided to start diminishing the rate at which its buying securities, interest rates are still at record low levels. Hence, its still very tough to get decent yields through buying high grade bonds with maturities below 15 years. If rates start going up, high grade bond prices should plunge, and this makes them risky at current market prices. On the other hand, we can find most international corporations increasing their cash returns to shareholders through dividends and buybacks. Here I chose three high quality oil and gas stocks that are poised to keep paying high cash dividend yields.  

A Dividend King  

Royal Dutch Shell (RDS.A) has never cut its dividend in over 70 years and its current dividend yield, at 5.2%, is one of the highest among peers, as its the company's main way to returning cash to shareholders. The company has distributed over $11 billion of dividends in the last twelve months, including the scrip dividend, which accounted for 44% in the second quarter this year.

In addition, the company is on track to complete $5 billion of buybacks before 2013 comes to an end. On the other hand, Shell's new projects are expected to generate operating cash flows of $175 billion at $80 Brent and $200 billion at $100 Brent into 2015. This means the company will be able to increase its operating cash flow by 30% to 50% over the 2008 to 2011 average. Shell, which is held by Scott Black, trades at 2014 8.57 times earnings and 5 times EV/EBITDAX.  

Cash Returns Will Drive Performance  

British Petroleum (BP) is now recovering fast from the 2010 Gulf of Mexico incident that erased well over $40 billion from the oil major's market capitalization. Now, the company expects cash margins from its major projects starting up in 2014 to be twice the average of it current portfolio. The company has recently decided to increase its quarterly dividend by 5.6% and use $10 billion from additional asset sales to increase distributions to shareholders in the coming two years – mostly through buybacks. According to most analysts, British Petroleum shall pay a 5% dividend yield in 2014 and the company should be able to keep increasing its cash payout at the current pace. Held by Baupost's Seth Klarman, British Petroleum sells for 2014 8.8 times earnings and times 5.3 times EV/EBITDAX.  

The Italian Cash Cow  

Eni (E) is an authentic cash cow for its shareholders. I believe the company will be able to sustain a greater than 6% cash dividend yield in 2014 even when the company's estimated 2015 free cash flow (FCF) yield is at just 4%. Asset sales as well as high oil prices should help the company meet its capex requirements and to continue giving back cash to shareholders through dividends. The recent sale of its stake in Sever Energia to the Novatek-GazpromNeft Joint Venture represents a clear hint into the company's strategy. After all, Eni's portfolio has several high quality disposal candidates which could attract the industry's interest – the first disposal candidate that comes to my mind is the remaining 8% stake Eni owns in Galp. The Italian oil and gas leader, which is held by Tom Gayner, sells for 12.5 times 2014 earnings and 5.5 times EV/EBITDAX.  

Bottom Line  

If you were to build a portfolio just with these three stocks you would own a portfolio which pays an increasingly high yield thanks to rock-solid companies that are constantly ameliorating their operating cash flows. Overall, I think your money would be safer here than in any 10-year high grade bond trading well above par.

Guru Discussed: Scott Black: Current Portfolio, Stock Picks
Seth Klarman: Current Portfolio, Stock Picks
Stocks Discussed: RDS.A, BP, E,
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