Why Dividend Growth Investors Should Avoid Royal Dutch Shell and Total

Editor's note: A previous version of this article used the RDS-B ticker instead of RDS-A while discussing foreign withholding tax. The Fool regrets the error.

Big oil companies are often viewed as perpetual annuities, with consistently growing dividends. Indeed, the best oil majors meet this criteria by offering dividend security and growth dependability. This article is designed to warn investors about two specific European oil majors with very high yields that some might find enticing. Upon further examination, however, these two companies are far inferior to American alternatives -- both in terms of earnings and dividend growth. 

Unreliable dividend growth
Total SA (NYSE: TOT  ) and Royal Dutch Shell (NYSE: RDS-A  ) are European oil giants whose 5.1% and 4.7% yields are far above the industry average and may seem appealing at first glance. 

Company Yield 20 year dividend growth (CAGR) 5 year dividend growth (CAGR)
TOT 5.10% 6.11% 0.06%
RDS.A 4.70% 10.57% 1.39%
XOM 2.70% 5.99% 8.18%
CVX 3.50% 7.26% 7.95%
IND AVG 3.50%    

Data from Fastgraphs

Dividend growth investors might be fooled by the 20-year growth rate. The five-year rate shows that these European oil giants are far less dependable when it comes to dividend growth. Indeed, Royal Dutch Shell did not grow its dividend at all from 2010-2011, while Total actually cut its dividend by 6% and 3% respectively for those two years. 

Another thing for income investors to consider is that these foreign companies have tax withholdings of 25% for Total and 15% for Royal Dutch Shell. This brings the effective yield for Total to 3.83% and Royal Dutch Shell to 4% (although most investors will be able to offset the impact of these withholdings with foreign tax credits). 

Some investors might be thinking, "the yield is still higher than ExxonMobil and Chevron, doesn't that compensate for the lower dividend growth?" The answer to this is "no" because slower dividend growth isn't these European oil companies' only problem.

Lower efficiency and profitability

Company 3 yr avg revenue growth 3 year avg EPS growth ROA ROE Operating Margin Net Margin
TOT 6.90% -7.20% 4.90% 11.6% 10.50% 4.90%
RDS.A 6.70% -6.70% 4.60% 8.9% 7.70% 3.60%
XOM 4.60% 2.30% 9.60% 19.20% 13.20% 7.40%
CVX 3.80% 4.00% 8.8% 15% 15.70% 9.40%
IND AVG 9.40% 4.80% 6.70% 6.70% 14% 6.10%

Data from Morningstar

As seen above, Total and Royal Dutch Shell have struggled recently with declining earnings as well as lower operating efficiencies and profitability.

Now, some would argue that Total's lower earnings are due to its massive investment designed to increase production by 13.5% by 2015 and 31% by 2017. 

Total is attempting to grow aggressively through projects such as the Yamal LNG (liquefied natural gas) export terminal in Siberia with 16.5 mtpa (million metric tons/year) export capacity. The first exports are scheduled for 2017. This project's capacity is comparable to the Sabine Pass LNG export terminal being built on the Gulf Coast by Cheniere Energy Partners (14 mtpa with expansion potential to 21 mtpa). 

A second LNG export terminal is under consideration in Papua New Guinea. This project (called Elk-Antelope) is designed to export LNG to Asia. It is situated atop a natural gas formation estimated to hold over five trillion cubic feet of natural gas.

The Fort Hills oil sands project in Alberta is scheduled to come online in 2017 and is expected to produce 180,000 bpd (barrels per day). The company is also investing aggressively in deepwater offshore drilling with projects off the coasts of Brazil and Africa. 

In addition to its aggressive-growth ambitions, Total is targeting 8% decreased capex (capital expenditure) spending in 2014. This is an effort to boost profitability. 

Of course ExxonMobil is planning its own 6.36% capex cut in 2014 and 17.6% cost reductions by 2015. Meanwhile Chevron is planning on a 20% production increase by 2017 while keeping capex constant.

Royal Dutch Shell bets on LNG, on an epic scale
Royal Dutch Shell is attempting to forge a comeback after several years of misfires. An example of this was the $5 billion spent at Beaufort, Alaska. After eight years (with no oil production), the company abandoned the project. Now a new CEO, Ben van Beurden, is at the helm and determined to steer a better course. 

The company is planning on selling $15 billion in assets between 2014-2015 and focusing on LNG exports and offshore drilling. This includes the construction of the largest ship in history, the Prelude, to act as a floating LNG liquefaction and tanker loading terminal. The estimated cost is 20% lower than land-based LNG export facilities, assuming the project can be accomplished on schedule and on budget. 

Companywide, management is targeting a 20% decrease in total capital expenditures for 2014 in order to increase profitability.

When it comes to increasing profitability Total, Royal Dutch Shell, Exxon, and Chevron are all planning on increased production and lower costs. This will increase margins across the board, raising "ok" margins to "good" for the European majors, but "good" to "great" for the American majors.  

Bottom line
Dividend-growth investors seeking a major oil company for safe and consistent dividend growth should not look to Total or Royal Dutch Shell. Instead, investors should look to their American counterparts such as ExxonMobil or Chevron. The slightly higher yields of the European oil majors are not enough to compensate investors for slower and less-reliable dividend growth, nor for their lower profitability. 

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