A feature of the modern business landscape is that to an extent it is dominated by some massive organisations. Those that readily come to mind for most people would include Amazon, Apple, Google and Microsoft. Less recognisable to those who do not regularly acquaint themselves with matters commercial would be Saudi Arabia's Aramco oil business but it is truly a Titan In the sector. In fact until recently it was the most valuable business by market capitalization in the world. We have discussed in several previous briefings the problems that face the oil sector based immediately on the fallout from the Coronavirus pandemic but also perhaps a symptom of a much more long-term malaise. This is reflected in Aramco's latest earnings. Figures have just been released in which the company reports a net income of around $6.6 billion in the three months to 30 June which is a 73% fall from the same period last year.
However, Amin Nasser, the chief executive of Aramco, when discussing the results opined that 'the worst is likely behind us'. Oil prices have bounced back somewhat after falling from nearly $70 a barrel at the start of the year to under $20 in April and are now trading at around $44 a barrel for Brent Crude, one of the key market benchmarks. Mr Nasser also noted that demand in China was almost back at pre-pandemic levels. Not everyone in the sector seems to share this level of confidence though. BP has recently announced a major reduction in its dividend. Aramco though is not following suit. At the start of the year it pledged to pay out dividends of $75 billion for the year. It has just confirmed that it has no intention of not doing so. In confirmation of this, it announced that it would as planned pay a quarterly dividend of $18.75 billion, the largest in the world.
There are perhaps several factors in play here. This is an expensive option for Aramco. It generated free cash flow for the period of $6.1 billion, far less than the cash outflow that is needed to pay the dividend so Aramco might need to dig into its accumulated reserves to do so. But the company raised a record $25.6 billion on its first public offering in December 2019, which admittedly seems a lifetime away at the moment. It will not want to disappoint shareholder expectations so soon after. The announcement that the dividend is to be paid as planned is also a statement of confidence in the future. The company may even raise loan capital or bonds to generate cash for the dividend. This is despite the fact that its gearing recently jumped to around 20% having previously been negative not that long ago.
Despite the existence of minority shareholders, the company is effectively controlled by the Saudi state. Crown Prince Mohammed bin Salman has been trying to diversify the country's economy but at this stage oil sales still provide the bulk of national revenues. The IMF forecasts that the economy will contract by nearly 7% this year. Production has been erratic this year with at one stage output rising to record levels of 12.1 million barrels a day in April despite the pandemic because of a price war with rival producers although it has now fallen back again. With stories continuing to circulate that the long-term future is far less certain than it has been for many decades, the company and the Saudi state both probably feel that this is the right time to send a message to the rest of the world that the oil business remains alive and kicking. Continuing to pay large dividends when economic logic would seem to suggest that you should not be doing so makes more sense when looked at from a strategic rather than a purely commercial perspective.
Wayne Bartlett is an author for accountingcpd. To see his courses, click here.
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