Could Dragon Oil Be Ideal Stock for Dividend Growth?

It is difficult to pinpoint precisely when it all started but for a while now there has been growing chatter among market-watchers, commentators and bloggers in the United States about a neat “new” concept called dividend growth investing. The clue is in the name of course, but put simply it’s a technique that reinvents the dividend investing wheel, throws in a heavy dose of rear-view mirror analysis and sells itself as an ideal antidote to a low interest rate environment.

As opposed to a conventional dividend formula that might, say, look for sustainable high yields, stalwart performers and strong cashflows, dividend growth investing seems to find more favor among investors looking for attractively valued stocks combined with dividend progression. The idea is to find companies that look like they might be able to increase dividends over the long-term, thus giving the canny investor the benefits of regular (and inflation busting) payouts and likely capital growth in return for very little ongoing work. I’m frankly not sure whether this is really anything new or not…

While dividend growth investing may be a hot investing topic in the US, here in the UK the opportunities for investors that might want to adopt or adapt the strategy are less certain. Indeed, after a couple of distorting factors, dividend growth actually slowed in the first quarter of this year. But there were exceptions, and some of them came from sectors that aren’t necessarily associated with widespread dividend payouts.

Can Dividends & Oil Really Mix?

For anyone that bought shares in Tullow Oil (LON:TLW) at 100p eight years ago, the intervening period has been a quite beautiful experience. Its price has more than quadrupled, profits have broken $1bn, it has brought a world-class field (Jubilee, offshore Ghana) into production and, perhaps more importantly, has shown the wit and luck to keep making massive discoveries. The dividend doubled to 12p last year as cash from Jubilee quite literally poured in but Tullow, like the majority of oil companies, has always had to play it safe with its payments to shareholders.

Of the 130+ oil and gas companies listed in London only around ten actually pay a dividend, ranging from pension fund favorites like Shell, BP and Glencore through to AIM quoted minnow Melrose Resources. Meanwhile, Tullow has quite rightly capped its payouts in recent years when heavy capex projects have put more demands on its cash. Indeed, while last year’s dividend was well covered at 6x, the yield is only 0.50% largely because Tullow’s shares are relatively expensive – the stock trades on a P/E ratio of 27.1 against an industry average of 7.37, which effectively smothers the yield of the £13bn market cap company.

In fairness, that isn’t bad news for Tullow shareholders that have stayed the course and are now being rewarded for their loyalty. But it does mean the stock isn’t necessarily an immediate option for income investors. So, for dividend hunters that fancy the upside potential of an oil stock (and the current full price for a barrel of brent crude) plus a dividend to boot, is anyone else offering a better deal?

Dragon Oil Public Co (LON:DGO) is the next largest London listed oil stock after Tullow in terms of market capitalization, albeit £10bn smaller. It trades on a P/E of 6.68 and has a dividend yield of 2.3%. Unlike Tullow, where the broker consensus hovers between “hold” and “buy”, Dragon stock is rated a “strong buy” among analysts (although we've discussed in the past the pitfalls of listening to analyst recommendations).

Stock Comparisons are Tricky

Comparing oil and gas stocks is notoriously difficult verging on pointless when you start taking into consideration exploration and production strategies, geopolitics, expected long term outcomes and management ability, etc.. However, comparing the fundamentals of these two stocks – whose production rates were not a million miles apart last year (78,200 boepd for Tullow and 61,500 barrels for Dragon) – raises some interesting points.

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