Royal Dutch Shell (RDS.B) on the New York Stock Exchange) looks to be a fairly strong blue-chip company with a massive market cap of $217 billion. It is by far the biggest publicly traded company that’s headquartered in the United Kingdom. Shell explores for and extracts crude oil, natural gas and natural gas liquids. It also liquefies and transports gas all around the world.
The stock is up 18% year to date and it has outperformed the S&P500 Index over the last 12 month period. What attracts many investors to Shell is its high dividend yield of 6.90%. But with high yield comes high risk. Some investors have started to express worry about the sustainability of Shell’s dividend distributions. And they have good reason to be.
Back in 2015, the payout ratio for Royal Dutch Shell during the first quarter was 66%, and in the second quarter it was 74%. At those kinds of levels the dividend wouldn’t have been at risk. However the company is really feeling the effects of lower commodity prices this year. RDS.B currently has a payout ratio of 323%. That is not a sustainable figure at all.
The general consensus for the stock by analysts still remains a solid buy today. It’s true that low oil prices have extended the company’s payout ratio, but investors still believe Shell is a profitable company and is a good long term investment. This is because Shell has many moving parts and is a well oiled machine.
Shell currently has 4 major business strategies so if one part is losing money, another part can subsidize the loss. The first business segment is upstream in the Americas, which manages the upstream business in North and South America. It searches for and recovers crude oil and natural gas, transports gas and operates the upstream and midstream infrastructure necessary to deliver oil and gas to market. Upstream Americas also extracts bitumen from oil sands that is converted into synthetic crude oil. It comprises operations organized into business-wide managed activities and supporting activities. The next segment is Upstream globally which does a lot of the same things but outside the Americas. Its activities are organized primarily within geographic units, although there are some activities that are managed across the business or provided through support units. The third part of the business deals with downstream management, which deals with manufacturing, distribution and marketing activities for oil products and chemicals. Manufacturing and supply includes refinery, supply and shipping of crude oil. Finally Shell has a projects and technology division which manages the delivery of Shell’s major projects, provides technical services and technology capability covering both upstream and downstream activities. It is also responsible for providing functional leadership across Shell in the areas of health, safety and environment, and contracting and procurement.
The biggest unknown factor right now is the price of oil and gas in the near future. A barrel of oil has climbed back up to $50 over the past month but we don’t know if it will hold. Most people agree that oil will eventually increase back up to $75 or more per barrel at some point in the future. But nobody knows when that will happen. If oil stays at the current price of $50/barrel then there is a high probably of Royal Dutch Shell to cut its dividends. The ADR stock that trades in the U.S. currently pays 94 cents per share per quarter. A modest cut of 24 cents to 70 cents per share would drop the dividend yield down to about 5.1%, which would be more sustainable in the long run. But if energy prices go up next year then maybe Shell wouldn’t have to cut its dividends. Only time will tell.
This author has no positions in any stock mentioned above and does not plan to open any positions for at least 72 hours after publication of this article.