When a company’s share price gets hammered down to the extent that the dividend yield rises to high single- or double-digits, the market is effectively ‘pricing-in’ a dividend cut.
The market is rarely wrong on these occasions.
We saw it happen to banks and insurers as the financial crisis unfolded. And we’re seeing it now with miners and oil companies as over-supply and the collapse of commodities prices take their toll.
In the mining sector, dividends have toppled at Anglo American, Glencore and Rio Tinto, leaving BHP Billiton as the only FTSE 100 giant with its payout yet to be slashed — although an announcement of a ‘rebasing’ looks just about nailed-on to accompany the firm’s half-year results on 23 February.
Meanwhile in oil, dividends from mid-sized and smaller operators have already been decimated. However, heavyweights Royal Dutch Shell (LSE: RDSB) and BP — as well as French giant Total — have all recently pledged to maintain their payouts.
I believe the oil supermajors could defy the sceptics. And of the two Footsie giants, I see Shell as a particularly attractive proposition.
A bold commitment
Shell’s results for 2015 didn’t make for pretty reading last week. The headline numbers were awful: revenue down 37% and bottom-line profit collapsing by 87%.
Nevertheless, the board fulfilled its commitment to maintain the dividend at the previous year’s level and reiterated its earlier guidance for the year ahead: “Shell’s dividends for 2015 were $1.88 per share, and are expected to be at least $1.88 per share in 2016, as previously announced.”
Given the collapse in revenue and profit in 2015, and the price of oil having further declined this year, how can Shell possibly make such a commitment?
Levers
It’s all about cash flow. Shell used a number of ‘levers’ to manage cash flow during 2015, including reducing operating costs and capital investment, and increasing borrowings. There will be more of the same this year, with the soon-to-be-completed acquisition of BG Group providing further levers. For example, we’ll see a reduction of some 10,000 staff and direct contractor positions in 2015-16 across both companies.
In addition to planned actions to manage cash flow, management has scope for more lever-pulling to fulfil its dividend commitment: “Shell will take further impactful decisions to manage through the oil price downturn, should conditions warrant that.”
Prospective 8.7% income
Shell’s high yield is being boosted for UK investors by the trend in the $/£ exchange rate. The company’s $1.88 payout in 2014 translated to 118.48p.
For 2015 — based on the sterling dividends paid for the first three quarters and the current exchange rate for Q4 — the same $1.88 payout will translate to around 125p.
And if the current exchange rate were to prevail through 2016, we’d be looking at a payout in the 128p-129p area. Shell’s shares are trading at 1,480p, as I write, so the potential income works out at 8.7%.
Life-changing income stream
Of course, no company with a yield as high as Shell’s is risk-free. However, management does have much within its power to maintain the dividend through the downturn and shows a strong commitment to doing so.
Shell’s boss rightly says the acquisition of BG “marks the start of a new chapter … rejuvenating the company, and improving shareholder returns”. If Shell can get through the oil price rout, investors buying into the current yield could have a supercharged — perhaps even life-changing — income stream in decades to come.
