Extracts from an article by Nigel Kelly: 19 FEB 2016

Summary

RDS acquired BG Group on February 15, 2016.

The BG shares have been delisted.

RDS/BG now yields over 7.5%.

$60B is required Annually to cover Capex, Debt, Dividend and other Cash Commitments.

Its Cashflow from Operations is only $30B.

Background

Royal Dutch Shell completed its acquisition of BG Group on Feb 15th 2016. The full year 2015 results for both companies have been released in recent weeks. I wanted to review the full years earnings reports and assess the dividend safety for the combined entity.

Is the RDS dividend safe for 2016 and beyond?

Overall RDS will have a cash deficit of $50B in 2016.

The $50B deficit will be funded by:

1. $20B new debt
2. $10B of proposed asset sales in 2016
3. $5B indicated capex and synergy savings*
4. $15B cash will thus have to come off the balance sheet

* Please note I have not accounted for the debt and interest repayments on the $20B and hence this part of my analysis is on the optimistic side of the fence.

I just about believe that RDS will pay its dividend in 2016, but I predict RDS will do a lot of damage to the balance sheet to maintain its dividend. Given the current oil price environment, it could well deplete the cash on its balance sheet from $40B to $20B over the course of 2016.

The combined commitments (after capex) of dividends, debt reduction and other various commitments will probably run in the $25B-$30B range for years to come.

RDS/BG needs to increase revenues to generate more free cashflow.

And I don’t see a share buyback happening any time soon despite what management might say.

Conclusion

Shell/BG is not quite adding up for me.

In the short term, it has zero Free Cashflow. It must issue debt or sell assets to pay a dividend and to pay down its debt commitments.

In the longer term, I am not confident the Free Cashflows will cover the substantial dividend and debt commitments of the business.

As such I sold off half my RDS Shell this morning at £16 per share.

I will consider re-entering the position in the event of a substantial price collapse or perhaps look at other oil stocks that have no M&A risk. Several beaten-up industrials like Emerson (NYSE:EMR), Boeing (NYSE:BA) and Eaton Corp (NYSE:ETN) offer compelling values with decent Free Cashflows that can cover strong dividend yields alongside good buyback policies.

I believe Shell is a risky investment for income investors.

Disclosure: I am/we are long RDS.B.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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