When the Commodity Supercycle petered out in 2014, heavily indebted mining giants and small oil producers were quick to slash dividends in an attempt to bring their precariously perched balance sheets back from the brink. Yet oil majors have so far maintained sky-high payouts through a combination of cost cuts, debt and neglecting capex. But is luck about to run out for income investors interested in the Shell (LSE: RDSB) 6.7% yielding dividend in 2017?
Unsurprisingly, the answer to that question hinges on what oil prices do. There’s no way for us to accurately predict where oil prices will go, but the market’s lack of enthusiasm for the OPEC supply cut agreement doesn’t leave me with much hope that they’ll be skyrocketing.
But if prices remain around their current $50-$55/bbl range, Shell’s dividend is looking significantly safer than it has been over the past two years. That’s because the combination of cost-cutting, highly profitable downstream refining and trading operations mean Shell’s operations are still generating significant cashflow. In Q3, operations provided $8.4bn in cash when the average realised price of each barrel of oil and gas equivalent was $40.43.
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Now, Shell still had to issue $8bn of new debt to cover the $2.7bn cash dividend (a further $1.1bn was paid in shares), as well as costs related to the BG acquisition and significant interest payments. But, if oil can stay at or above $55/bbl then Shell should be quite close to being free cash flow-positive for the first time in years.
That said, if oil prices don’t reach this level then income investors are likely to be in for a rough ride as $78bn of net debt means a third successive year of uncovered dividends would be dangerous for Shell’s balance sheet. Quarter end gearing of 29.2% is rapidly approaching the upper end of management’s target, so if oil prices remain depressed and asset sales are minimal then dividends will be in considerable danger of being slashed.
More cash needed?
Shell’s dividend isn’t the only one beholden to forces outside of management’s control as investors in emerging markets-focused Aberdeen Asset Management (LSE: ADN) know all too well. Fourteen straight quarters of outflows from Aberdeen’s funds have led to earnings per share falling for each of the past three years. Meanwhile, a progressive dividend policy means the shares’ 7.68% yielding dividend are now covered only 1.07 times by earnings.
With net cash at the end of September totalling £548m and annual dividends only £280m, it would appear that management could stomach uncovered dividends in 2017. Unfortunately the situation is more complicated than it would seem. That’s because £335m of this cash is a regulator-mandated capital buffer that’s set to rise to £475m in the coming year. With cash generated from operations falling 31.9% year-on-year in 2016 to £362.9m, it’s unlikely that Aberdeen’s dividend could stand another year of even worse trading performance. With US interest rates rising and emerging markets once again tanking, I’m fairly bearish on Aberdeen’s dividend outlook in 2017.
