The reduction on federal tax dividends contained within the $350 billion US tax cut package is likely to make oil stocks more attractive to some investors, said analyst Frederick P. Leuffer of Bear Stearns & Co. Inc., New York.
"For shareholders subject to the top income tax rate, the cut represents an effective boost in after-tax dividends of more than 38%. This is likely to be seen as good news for high-yield stocks, where dividends are perceived to be secure, such as certain major oils," Leuffer said in a May 27 research note.
Current dividend yields sometimes can provide a better indicator of an oil company's financial strength than can the most sophisticated cash flow discount model, he said.
"If a company's dividend payout, based on 'normalized earnings,' is in line with its history, then dividends can be used as one measure to gauge downside risk," Leuffer said.
High-yielding oil stocks, particularly those of the majors, may be less vulnerable to a drop in oil prices because of the dividend yield protection, he said.
"Based on our new projections, the international integrated oils, as a group, continue to look more attractive than the domestic oils," Leuffer said. This is because of higher dividend yields and "also because of lower earnings sensitivity to declining oil prices, stronger balance sheets, significantly higher returns on capital employed, and generally better prospects for oil and gas production growth."
In addition to favorable tax treatment on dividends, US shareholders of certain oil companies based outside the US could "reap a benefit from the decline in the dollar relative to European currencies," he said.
Leuffer believes oil prices are vulnerable to "a significant correction," and he bases his 2004 earnings estimates for companies in his coverage universe upon $18/bbl West Texas Intermediate spot prices.
