At first glance pitting Woodside Petroleum Limited (ASX: WPL), one of the top dividend paying energy companies, against Santos Ltd (ASX: STO) may look like a one-sided battle. A bit like watching The Rock wrestle Clive Palmer.
But given Santos is about to commence the strongest period of production the company has seen, while its share price is at decade lows, a closer look suggests we may have a contest on our hands.
Woodside Petroleum
Trailing dividend yield: 8.9%
Woodside Petroleum had a spectacular full year result for 2014, producing record operating earnings, which allowed the company to pay out a huge dividend yielding almost 9% and clear its balance sheet of debt.
That certainly makes Woodside seem an attractive candidate for a dividend portfolio, but is it sustainable going forward?
Despite strong contracted LNG pricing in 2014, Woodside is expecting a drop in operating earnings going forward as the low oil price impacts earnings and production growth slows. At a Brent oil price of US$65 per barrel Woodside forecasts operating cash flows to average around US$2.7 billion between 2015 and 2018.
But before this operating cash flow can make its way to eager investors, Woodside needs to allow for future growth by allocating a portion to exploration and growth projects. Woodside has currently committed to around US$500 million of capital expenditure per annum between 2016 and 2018, but there is potential for that to rise significantly to as much as US$2 billion depending on the needs of other growth projects like the Browse FLNG project, Canada's Kitimat LNG project, and other exploration.
The net result could be less free cash flow than the US$1.764 billion paid out in dividends for the full 2014 financial year.
Santos
Trailing dividend yield: 4.2%
The situation for Santos is almost the inverse of Woodside Petroleum. Santos is expecting stronger production growth going forward as the full benefit from its PNG LNG and GLNG investments come online.
Santos is forecasting production growth of up to 18% for the full year 2015 (FY15) to as much as 64 million barrels of oil equivalent (mmboe). At the same time, and despite still having relatively high exposure to oil-linked pricing, a 10% reduction to production costs going forward means Santos expects to achieve positive free cash flows at US$60 per barrel by the fourth quarter of 2015.
The completion of major projects will also see capital expenditure fall by 44% to $2bn in 2015, freeing up cash to reward investors.
However compared to Woodside Santos still has comparatively high levels of debt. As I noted in Santos' recent Dividend report card Santos has gearing (net debt divided by net debt plus equity) of around 44% which will likely be targeted with free cash which means less cash to pay out to investors.
So which dividend payer to buy today?
Conservative investors who require more certainty over dividends for income should consider Woodside. The dividend is likely to fall compared to the 2014 high, but the company's low debt position means that even with falling operating earnings a high percentage will be free to distribute to investors. The company is maintaining a focus on long-term growth going forward but is well positioned to do so with a strong balance sheet.
Santos meanwhile would be more suited to investors comfortable with volatility. The strong production growth profile means that if the price of oil keeps rising Santos will be in a position to produce impressive operating cash flows. Not only will this result in a higher dividend, but also capital appreciation in the current share price.
