Over the years, Royal Dutch Shell (RDS.A) (RDS.B) has consistently been a top dividend yielder. Since 2015, it has paid either the highest yield among the five oil majors, or come in a close second to rival BP.
But the recent oil price plunge has thrown the industry for a loop. Crashing share prices have pushed yields to all-time highs, and some oil companies like Occidental Petroleum have already thrown in the towel and slashed their dividends to the bone.
Could Shell be poised to do the same? Let's dig deeper to find out.
Royal Dutch Shell managed not to cut its top dividend during the last oil price downturn. Image source: Getty Images.
No dividend cuts
Shell managed to get through the oil price downturn of 2014-2017, when oil prices toppled from over $100 per barrel to less than $30 per barrel, without cutting its dividend. However, it hasn't increased its dividend, either. Its steadily increasing yield since 2018 is thanks to a slowly declining share price in dollars (as its name implies, Shell is headquartered in the Netherlands).
Like some other oil majors, Shell switched to a voluntary scrip dividend program to help it through the lean years, meaning it allowed investors to accept dividends in shares instead of in cash. The program has since been discontinued, but it allowed Shell to preserve its capital.
The company also increased its debt load and cut costs to adjust its operations to the new normal of low oil prices. That was enough to get it through the last oil price downturn. It's worth noting, though, that Occidental Petroleum had increased its dividend every year since 2003, and hadn't cut it since the early 1990s. So getting through the last downturn without a cut is no guarantee of a safe dividend today.
All about that cash money
A company usually won't cut its dividend except as a last resort. Specifically, if it's not generating enough free cash flow to cover its dividend and capital spending needs and can't (or won't) take on more debt to cover the dividend temporarily, a dividend cut is much more likely.
In a statement on March 23, Shell CEO Ben Van Beurden outlined the company's plan to free up additional cash:
Today, we are announcing that we have embarked on a series of operational and financial initiatives that are expected to result in:
- reduction of underlying operating costs by $3-4 billion per annum over the next 12 months compared to 2019 levels;
- reduction of cash capital expenditure to $20 billion or below for 2020 from a planned level of around $25 billion; and
- material reductions in working capital.
All told, Shell's management believes this will result in $8 billion to $9 billion of additional free cash flow. The company is also suspending its share buyback program to preserve capital.
Will it be enough?
In 2019, Shell brought in $15.8 billion in profits, but paid out $15.2 billion in dividends to its shareholders. That results in a payout ratio of 0.96. The good news is the number is less than 1, meaning Shell isn't paying more in dividends than it's earning. The bad news is that it's barely less than 1, meaning Shell doesn't have a lot of wiggle room before it's paying out more than it earns.
Looking at cash flow, Shell brought in $42.2 billion in cash from operations in 2019, but still managed to post negative net cash flow for the year. The biggest items sucking up all that cash, besides the dividend, were $23 billion in capital expenditures, $14.3 billion in debt repayment, and $10.2 billion in share repurchases.
But remember, Shell is planning to cut its operating costs and capital expenses to the tune of at least $8 billion, and it's suspending its share repurchases, which all told would free up $18.2 billion -- more than the amount of dividends paid to shareholders last year. It also has $18 billion in cash on its balance sheet, and $10 billion in existing credit lines.
And if, in a pinch, the company needed to borrow more money, it certainly could, given its high credit rating and its debt-to-EBITDA of 1.2, which is in the middle of its peer group.
A rough road ahead
Shell's financial performance is almost certainly going to suffer in 2020 as oil prices decline due to oversupply, and the novel coronavirus pandemic keeps fuel demand low. However, the company is in a strong financial position to maintain its dividend. The risk of a cut seems low, especially compared to smaller companies in the energy industry. In fact, Shell is one of the few oil companies that a dividend investor might want to take a serious look at buying today.
Of course, there's a lot we don't know about how the current macroeconomic situation is going to play out, so investors should be aware of the risks associated with investing in even a top company in this sector.
