For Fat Dividends Think Like an Owner:

Let Variable Dividends Unlock Resource Riches for You

If you’re like most investors, you probably associate dividends with steady if not boring investment returns. If so, you probably haven’t heard about the new generation of natural resource companies that pay “variable” dividends.

Like employees who draw a regular paycheck, most investors are content to receive the same payout throughout the year. And like the best employers, well-run companies will provide an annual bump to keep up with inflation.

But when companies pay variable dividends, investors are effectively business partners. The cash we take away every quarter or month is constantly re-set to how much money the business makes. And when the business grows, our dividends increase along with it.

From copper miners to oil and gas producers, natural resource companies’ profits are shaped by three factors: How much they produce, what it costs to get that output to market and what they can sell it for.

Companies generally have control of the first two factors. But the third—selling prices for copper, oil etc—they do not.

When prices for commodities are volatile, so are natural resource companies’ earnings. But by tying dividends to earnings with variable dividends, management never pays out more than it can afford. And when selling prices rise, they pass the added profit directly on to investors, like business partners.

Of course, when commodity prices drop, investors will share the pain—as dividends are pared back. And that’s what’s happening now. For example, last month the world’s leading mining company—Australia’s BHP Group (ASX: BHP, NYSE: BHP)—declared a semi-annual dividend roughly -40% less than what it had paid a year earlier. That was the result of lower selling prices for copper and iron ore, the company’s two main products.

Also last month, Pioneer Natural Resources (NYSE: PXD)—a leading US oil and gas producer—declared a dividend of $5.58 per share for payment in March. That was almost 50% higher than what it paid a year ago. But it’s -35% less than the September dividend, the result of a -33% drop in oil prices and -70% in natural gas from mid-summer 2022.

With their variable dividends cut, it’s hardly surprising stocks of BHP and Pioneer have dropped to meaningfully lower prices as well. Ironically, this is the time investors should be considering opening their wallets to buy them.

First, these stocks’ prices fully reflect the dividend cuts, and very likely more. The worst of the downside is behind them.

Second, China’s economy is re-opening from Covid-related lockdown. That’s steadying global demand and prices for basic commodities, limits risk of another big drop in resource companies’ profits and therefore more dividend cuts.

Third, this is still very early innings for the commodity up-cycle. That means much higher selling prices for everything from energy to copper, higher earnings for producers and massive increases ahead for variable dividends.

Demand largely sets prices near-term. And over the past year, it’s been heavily affected by myriad factors from weather and the war in Ukraine to how hot the world’s dominant economies are running, mainly the US and China at a combined 40% of global GDP.

The key to the long-term up-cycle, however, is supply. The primary mover is investment. And since 2014, it’s been severely lacking—with little indication of a rebound in light of the very conservative CAPEX plans industry is communicating in 2023 guidance updates.

So long as investment in oil and gas supplies is muted, long-term supply will not catch up to underlying demand. And once the Fed stops raising interest rates, sending prices markedly higher. That means variable dividends will ultimately return to the upside as well.

It’s likely the investors who bought variable dividend companies at their recent top will be reluctant to jump back in, at least until payouts have been increased for a while. That could limit upside in these stocks the next few months.

Investors who value a predictable payment over upside will probably want to look elsewhere for yield. But the cycle is on the side of natural resource companies paying variable dividends and their investors.

Those who can handle the volatility would do well to start taking positions now. Consider taking an incremental approach: Decide how much you want to own of a particular stock and buy one-third of it now, one-third in six weeks and one-third six weeks or so after that.

Investors interested in all things energy would do well to check out our Energy and Income Advisor, which my partner Elliott Gue and I launched more than a decade ago. But no matter what strategy or advisor you rely on, the variable dividends paid by natural resources companies will make inflation your friend—increasing your cash flow at many times the actual rate of inflation in coming years.

Here’s to your wealth!