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How Royal Dutch Shell Is Addressing Its Dividend Concerns

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Screen Shot 2015-08-04 at 22.49.59Christopher F. Davis: Sept 3, 2015


  • This article is a follow-up to my prior article addressing the company’s dividend concerns.
  • History won’t always repeat itself, so I felt I would talk about what the company is doing in detail and expand on my thoughts.
  • I am betting history continues.

As you know, Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) has been crushed in the last three months, and of course, over the last year since oil began its sell-off. At the time of this writing, oil is hovering around $40 and oil stocks have come off of their lows from last week. However, it could get worse before it gets better. Last week I wrote an article that addressed the Royal Dutch Shell dividend concerns. It was a highly controversial article, to tell you the truth. But it is important. The stock has a 7.5% yield right now. It did NOT raise its dividend to get here. It is not a red flag dividend. It is a result of rampant selling in the oil sector.

That said, the dividend being sustained is a real concern. But I outlined historically why I felt the dividend would not be cut. I mean, the dividend was maintained during the largest crises in our modern history. For 70 years, the dividend has been maintained or raised. I’m betting history continues. Management has stated return of capital is the largest priority for the company, and I discussed why I felt it would be maintained. I recommended buying now and lower because through dividend compounding, the stock, particularly a tax advantaged retirement account, could generate extreme wealth over the next 30 years. Even when oil eventually rebounds, whether it is in three months or three years, capital gains will be had. But my historical reasoning wasn’t enough for many of you. And that is fair. It is a different world in 2015 than it was in past crises. But while the threat to profits is real, the concerns over the dividend are overblown for fiscal reasons as well, and I strongly believe that the dividend is more than safe for the near to mid-term future.

So why am I so confident in Shell’s ability to maintain its dividend aside from history? Well I touched on this, but the company will do everything it possibly can to ensure the dividend remains. It is something they are proud of historically, but also as insiders who hold the stock. The company has already started laying off employees. Other weapons will include selling assets, cutting salaries and reducing exploration spending. The fact is this team and the company can manage its cash flow in times of oil crises. But the company can only cut to a certain level. Fundamentally the company is in much better shape versus 10, even five years ago, thanks to their ability to reduce costs when needed. Many of you were concerned about the BG buy. That has passed antitrust clearance as of this morning, and most analysts believe this was a good buy, albeit expensive. It will pay dividends (literally and figuratively) as the years go on.

So what specifically aside from massive recent job cuts and exploration reductions is the company doing? Despite exploration cuts, the Arctic drilling program is a go. It has also started selling assets, including its 75% stake in Tongyi, a Chinese lubricant supplier. It has also sold its stake in a Japanese refiner for $1.4 billion. Let’s not forget that Shell also is slowing down the share buybacks, even with its low share price being an attractive point to repurchase. It’s a balancing act. Less shares on the market increases earnings per share and can protect dividends. But sufficient cash needs to be on hand to pay dividends. Another thing to remember is that Shell’s Scrip Dividend plan allows dividends to be paid in shares of RDS.A (tax free) as opposed to in cash, whether you hold RDS.B or .A class shares.

Now, in terms of profitability, we know that profits are way down. But the company also has been diligently working to cut the breakeven point on the price of crude. Right now, it’s about under $80. Of course we are well below that now, so cash reserves would need to be tapped. Once all of the recent cost-cutting measures are in place, this number should decline much further. Specifically I am factoring in the Scrip Dividend, impact of buybacks, salary and spending reductions. Of course, the buybacks need to outpace the Scrip Dividend, else it is dilutive.

As we move forward, the company is financially preparing for a prolonged downturn. Despite that, there are no plans to adjust the dividend now or in 2016. The company is prioritizing its cash for debt service, then dividends and then a balance between buybacks and capital investment. So, the company intends to prioritize debt payment initially following completion of the combination with BG using surplus cash from operations and proceeds from asset sales to drive debt down. As cash flow increases from either increased volumes and/or higher prices, the company will restart a share buyback program, with a program of at least $25 billion, and again intended to start in 2017. There’s no change to these priorities. Management has stated “we have a very, very firm intention to deliver on these promises that we set out.”

Now, in the last quarter, and I realize oil is now lower on average, the company’s portfolio generated a return on capital of 7%. It generated cash flow from operations of $6.1 billion, but paid out just $3 billion in dividends in the quarter. There is still a lot of wiggle room here, and the company is not even close to cutting costs to the bare bones. To reiterate, the dividend, as underwritten, is to remain at the same levels for the next 6 quarters. As of now, the company is back to 2012 levels of spending. For capital investment it’s looking to do around $30 billion this year, 20% lower than last year and 35% lower than 2013.

So, while my first article talked about history, this article tried to pull in some supporting data and supporting actions to back up my assertion that management is serious about this dividend. While past performance is not a guarantee of what will happen in the future, and the company cannot survive $30 oil indefinitely paying this dividend, the company is prepared for the long haul and making moves now, expecting a rough road ahead. As 2015 continues, expect to see another $2.2 billion in asset sales. That is a good chunk of one full quarter of dividends, not counting actual profit or cash flow from operations. The company hasn’t reduced its dividend in 70 years, and that’s because it makes necessary moves like I describe above. I reiterate, at a 7.5% yield, for the long term, this is a name to be buying.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit “follow.” He also writes a lot of “breaking” articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box “Real-time alerts on this author” under “Follow.”

Additional disclosure: I hold RDS.A solely because the Scrip Dividend program provides these shares based on my holding of B class shares

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