Saudi Aramco: payout boost will lift yield of tight-held stock

A meagre dividend yield blunted investor enthusiasm for Saudi Aramco stock when it listed in Riyadh in 2019. The world’s biggest oil group is loosening its purse strings. On Tuesday it announced plans to add performance-linked dividends to its payouts. The company’s shares edged up almost 4 per cent on the news.

The performance-linked distribution is expected to mop up 50-70 per cent of annual free cash flow, after taking account of the base dividend and external investments. RBC analysts expect that to generate up to $12bn-$18bn of extra payouts next year. That would raise the dividend yield by as much as a fifth from 3.5 per cent.

Even so, the yield will be lower than for international oil majors. That is not a sign of stinginess. Majors paid out 30-40 per cent of their operating cash flow last year, according to Citi. Aramco paid out nearly half.

Rather, it reflects Aramco’s inflated valuation. The shares trade on 16 times forward earnings. That is a fifth lower than the average since it floated in 2019. The decline reflects the sharp fall in oil prices which pulled down first-quarter net income by a fifth. Nonetheless, the multiple is still more than twice the sector mean.

The elevated valuation reflects the slimness of the sliver of equity — about 2 per cent — listed by Aramco. The rest belongs to the state. Minority shareholders are mostly long-term and Gulf-based.

Aramco has some fundamental strengths. It has massive reserves. Its oil is cheap to extract. Its balance sheet is solid. In 2020, gearing rose to 23 per cent. High oil prices swiftly replenished its coffers. By the end of March, its gearing was minus 10.3 per cent.

Investment may also help Aramco’s shares. It is ramping up spending on oil and gas. This year’s $45bn-$55bn budget is a third more than last year’s. Its fossil fuel investments promise higher short-term returns than investments in renewables pursued by oil majors.

Aramco’s narrow focus is also a risk. The energy transition will leave stranded assets. Saudi control is an issue for many external investors, some of whom see Aramco as an arm of government.

The clarity and increased generosity of the new distribution policy are welcome. But without a bigger free float — and with it the prospect of robust price discovery — the shares should remain the preserve of Gulf specialists.