Aramco's Dividend Discipline Isn't Enough -- Heard on the Street

Oil industry investors have been rocked by two jarring dividend cuts this year, but the biggest oil company of them all has stayed the course. That discipline will do little to attract foreigners to Saudi Aramco, though.

It was a brutal second quarter for the entire oil sector: Profits were hit hard by Covid-19 lockdowns exacerbating an ill-timed price war. Saudi Arabian Oil Company had it worse than most because it also was a major contributor to massive output cuts that helped to stabilize the price of crude in the past few months. The company nevertheless confirmed it would pay $18.75 billion in dividends for the quarter. That isn't a great surprise given its majority shareholder -- the Kingdom of Saudi Arabia -- needs the cash and it is the one calling the shots at the company. Global investors avoided the company's December initial public offering on worries of political interference and an expensive share price. Both concerns remain.

On Sunday Aramco reported tough second-quarter results. Net income of $6.6 billion was in line with expectations, but cash flow disappointed and debt rose. A closely watched industry metric, net debt as a percentage of total capital, jumped to 20.1% from net cash of 4.9% last quarter. The company's target range is net debt of 5% to 15%. One reason for the jump is that Aramco started to consolidate the borrowings of Sabic, the chemical company it bought from the Saudi sovereign-wealth fund in June.

Privately owned supermajors BP and Royal Dutch Shell (RDS/A) both recently cut their payouts. However, luckily for minority investors in Aramco, dividends are one area where the kingdom's interests align with theirs. Over 98% of the dividends being paid go to cash-hungry Riyadh.

Sometimes the state's interests trump the company's, though. Aramco agreed in March 2019 to buy 75% of Sabic from the kingdom's sovereign-wealth fund for $69 billion to diversify its downstream business. Sabic's market value plunged earlier this year, but efforts to renegotiate the purchase price yielded only deferred payment terms.

Another example of misaligned incentives that hit the company's bottom line was Riyadh's ill-timed price war with Moscow in March. Aramco was ordered to open the taps and ramped up to produce 12.1 million barrels of oil on April 2, its highest ever daily total. Just days later, futures prices briefly fell below zero in the U.S. as the country ran out of places to store oil. Eventually, Saudi officials were major contributors to the successful effort by the Organization of the Petroleum Exporting Countries and its nonmember allies to stabilize crude prices closer to $40 a barrel. It was painful for Aramco -- its average oil production fell from 9.8 million barrels a day in the first quarter to 9.3 million in the second -- and there are no guarantees this cooperation will last.

Despite the tough quarter, Aramco's shares have outperformed those of their rivals, down about 6% year to date. By contrast, Shell's value has nearly halved and other rivals are down around a third or more. Aramco is an efficient, low- cost producer but its strong share performance is less about confidence and more about its investor base, who are primarily locals. Shares traded broadly flat on Monday at 33.10 riyals, still well above the 24 riyals that international investors said they would be willing to pay -- and that was before the pandemic hit.

Dividend discipline isn't likely to lure international investors now. It is possible that mounting financial pressure could force the kingdom to sell more Aramco shares in the future to nonlocal buyers, but doing so will require either a dramatic recovery in the price of oil or a lower asking price for shares.

Write to Rochelle Toplensky at rochelle.toplensky@wsj.com


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  08-10-20 1124ET
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