Banks and/or Oils?

Banks have been very kind to investors with a ytd gain of 13.5% (39 banks covered by AlphaValue) when the Stoxx600 is down 4.6%. The same can be said of Oils with Big Oils up 16.7% ytd. Banks tend to be perennial features of any diversified portfolio. Oils much less so since ESG diktat took the market by storm and most of ESG-branded funds dropped the sector. Untimely so.

Both sectors are dividend propositions and will not make any pretence to be otherwise even if Oils speak of growth when they pivot into green.

The following table is a reminder that Big Oils offer a yield equivalent to that of Banks, but their pay-out ratio is about 40% while Banks are getting closer to 50%. 

Dividend payers

Both sectors saw their 2021 earnings inflate beyond any dream due to two years of ultra-accommodating financial conditions which have help cut risk and prop up demand. That is about to end so the question is whether there is a degree of sustainability in such dividends? Both sectors have a history of accidents in this respect.

Oils and Banks dividends come and go

The short-term answer to dividend outlooks is that pay-outs are sustainable. Both sectors are experiencing upgrades to their 2022 earnings forecasts which is the closest proxy to a dividend upgrade. Both sectors are quite happy to pay out more, notably Big Oils lest some governments hit them with a windfall tax on their unexpected earnings.

Longer term, Banks will suffer from the two bog standard question marks: 1) what about rising risks when higher rates push a rising number of corporates to the wall ? and 2) what if higher short rates are not matched by a hike on the long end? On loan loss provisioning, the issue may well be pushed back to 2023.

Above all, European banks are over capitalised (P/book at 0.73x), so can absorb the odd blow. They had €730bn in equity in 2008 when entering the great financial crisis and now post €1,500bn to cover essentially the same balance sheet total. So, the odds are that Banks will pay out for longer if not much more. On a flattening yield curve, the issue is really how quickly very long money will want to plunge again into sovereigns when the yield becomes more attractive. That is a definite risk as the taste for fixed return is as strong as the planet is ageing.

Oils’ longer term outlook really hinges on what shareholders want. Do they prefer to invest in a green pivot (expensive and risky) or should they be managed as self-liquidating businesses by investing less (good for forward looking crude prices) and paying out more. The experience of Tobacco is that it can take quite a few decades and spring positive surprises in terms of business model creativity.

It is always hard to make a call on OPEC’s changing political balance, on an Oil industry dominated by autocratic governments and on sudden technological changes. Still, we would consider keeping an Oil exposure, collect the fat dividends and reinvest some of that return into direct green or impact projects to square the impossible mission of bringing together returns and a sense of green urgency. 

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