Can Shell maintain its dividend?

Royal Dutch Shell’s remarkable build up of cash, and the strength of cash flow in relation to dividend cost, suggests that Royal Dutch dividend bulls have a rational argument to support their bullishness.  

Sometime in the summer of 2014, the share price of the Royal Dutch Shell Group rose a bit above 2,400p – like the lark ascending – briefly gliding in the clear air of new share price territory. Then, without indication or warning – no ‘double top’ or anything of that sort – began its long descent to a share price of 1,463p last seen!

There, it appears to be on an annual dividend yield just under 7.7% and a market ‘short selling’ rating that is registered as ‘low’.

As we all know, a dividend yield at that level, suggests that the market believes that the dividend payout will be cut. The Chief Executive of Royal Dutch Shell persists in being bullish about the dividend and notes that he has considerable cost cutting to do that will assist him in that objective and buttress the dividend payout.

We know what has happened externally to the share price! But what has been happening to the company’s inside financial fundamentals, bathed in the lurid, yellow glow of the stage footlights, dramatically highlighting the collapse of the price of oil and gas? Are these internal indicators as awful as the outside share price that has fallen around 40% from the 2014 summer share price high point? And what does the market, in consensus of estimates, hazard as its guess of earnings and dividend prospects now?

For example, what has happened to the company’s holdings of balance sheet cash and ‘near cash’ (as near liquid assets are also known in my youth)?

Looking at the accounts for the company year which ended December 31^st 2013(the company’s  last full financial year before crude oil began its dramatic fall in mid 2014, cash and ‘near cash’ was shown as being nearly 9.7 billion euros. How much lower might it be now after the great collapse of the crude oil price?

By last June, the accounts tell us, balance sheet cash had not fallen but actually risen, to just under 27 billion euros – an increase of 187% . Three months later, on September 30^th of this year, it had risen again, this time to 31.7 billion euros. Which means, that on that basis, Royal Dutch Shell equity, at its current market share price, is now selling on a valuation of only four times the last valuation of the cash in its last published balance sheet.

Looking at operating cash flow, we see that although it has declined from 46 billion euros in the high crude oil price days of 2012, it was still flowing at an estimated ‘annualised’ rate of 32.5 billion euros last September. If that annualised figure proves correct (it scales up the rate of the reported cash flow in the nine months to what it would be over the year at that rate) then on that estimated basis the shares at the current share price are selling at under four times operating cash flow. If that is realised, it still represents 3.4 times the reported cash cost of the annual dividend last year.

The point which I think emerges from this partial analysis is that if  further promised cost cuts mean an improvement in operating cash flow, then the CEO’s bullishness about maintaining the dividend does not look without reason and the shares on that basis seem oversold by some measure.

So what does the market consensus suggest the company’s dividend prospects to be? Both notably and unsurprisingly, the market consensus has nothing to offer by way of estimation or guidance. There are no forward estimates of sales revenue, earnings or dividends because of the sheer uncertainty about the oil price both long term and short term. Moreover, influential figures in the insurance and pension fund industries are arguing for the company to drop its bid for BG.

Royal Dutch Shell has consequently become a speculation and should be viewed as such at the moment. What we need to know and what is impossible to know is the probable price of crude of oil over the next twelve months. The managers of the famously successful Wellcome Trust investment fund are reported in today’s press talking their book of large investments in Royal Dutch Shell and BP by suggesting that underlying demand must mean a recovery in the price of oil at some point and are reported as saying that they perceive the price of oil to be entering a U shaped recovery.

I contribute following basic points to the de bate:

• Oil has always been an extraordinarily volatile product. The latest sharp fall in its price is entirely consistent with that history of volatility; its big price movements always being hard to predict. To that extent, the current fall is not unprecedented.
• The Royal Dutch share price is already at a big discount to its net assets. On September 30^th its balance sheet showed that the company reported its net assets as being valued at 161 billion euros. That indicates the current share price is selling at a 20% discount to assets. The asset position is in turn affected by the price of oil but the share price has gone a very long way to discount that already. Currently, the Royal Dutch share price is so low, that an investor is paying nothing for earnings and getting one fifth of the September balance sheet assets for nothing.

As an equity investment, this oil company has a management that will inevitably adapt to change. In the short to medium term, that means plans to change the mix of assets, dispose of some assets, and cut costs. In the long term it will inevitably mean diversification of activities away from carbon fuels; probably, one suspects, investing in renewable forms of energy. (Remember that Toyota began life as a textile machine manufacturer and that the Levi Jeans Company began as a manufacturer of denim covers for the old wild west prairie wagons.)

Personally, I think that big oil company shares like these represent a great speculation and think that there is good reason for believing that the dividend can be maintained in the next year or so, particularly in light of the aforementioned strength of the company’s cash in relation to the dividend cost.