Royal Dutch Shell (RDS.A) – The Historic Dividend Cut

Royal Dutch Shell (RDS.A) and (RDS.B) had a historic dividend cut a few days ago. Shell cut the regular quarterly dividend on the ADR or ADS shares by approximately 66% from $0.94 per share to $0.32 per share. The cut was driven by the plunge in oil prices to historic lows and weakened global economic outlook. Oil prices were even negative for a day, which was unprecedented.

Importantly, the historic dividend cut was the first time Shell reduced the dividend since World War II, or in other words the first time in 80 years. The dividend cut will probably hit a lot of dividend growth and income investors pretty hard. The stock has over 100,000 followers on Seeking Alpha if we use that as sign of small investor interest in the stock. Shell was paying about a 10% – 11% dividend yield just before the historic dividend cut. However, the high yield was largely a function of declining stock price. The new forward yield is about 3.9% assuming an annual dividend of $1.28 on the ADR at the current stock price.

Overview of Shell

Royal Dutch Shell is an oil major that operates globally. The company was founded in 1907 and is headquartered in the Netherlands. The company has three operating segments: Integrated Gas, Upstream, and Downstream segments.  Royal Dutch Shell explores for and extracts crude oil, natural gas, and natural gas liquids; markets and transports oil and gas; produces gas-to-liquids fuels and other products; and operates upstream and midstream infrastructure necessary to deliver gas to market. The company also trades natural gas, liquified natural gas or LNG, oil, gas, diesel, etc. Royal Dutch Shell also produces chemical and polymers for other industries. Total revenue was $344,877 million in 2019.

Shell Historic Dividend Cut

Adjusted quarterly net profit fell 46% to $2.9 billion from $5.3 billion in the prior year. This was largely due to the severe and rapid decline in oil prices. The decline in net profit was probably not surprising. The cut to the dividend and its magnitude probably caught many investors by surprise. The historic dividend cut by Shell is summarized in the table below.

Shares	Q1 2019	Q1 2020
Royal Dutch Shell A Shares (RDS A)	$0.47	$0.16
Royal Dutch Shell B Shares (RDS B)	$0.47	$0.16
Royal Dutch Shell A Shares ADSs (RDS.A)	$0.94	$0.32
Royal Dutch Shell B Shares ADSs (RDS.B)	$0.94	$0.32

Note that the RDS.A and RDS.B ADR or ADS shares trade on the NYSE and each one represents two regular shares of RDS A and RDS B.

The move will reduce Shell’s cash requirement for the dividend by about $9 billion. This is not a small sum. The company paid out approximately $15.2 billion in common dividends last year. It also repurchased about $11.4 billion of common stock in 2019. Note that share repurchases were also suspended going forward. Clearly, the focus for Shell at this juncture is on maintaining liquidity, capital expenditures, and a strong balance sheet.

Specifically, the company stated:

The pace and scale of the societal impact of COVID19 and the resulting deterioration in the macroeconomic and commodity price outlook is unprecedented. The duration of these impacts remains unclear with the expectation that the weaker conditions will likely extend beyond 2020. In response, Shell has taken decisive actions to reduce our spending and position our businesses to compete in the current lower commodity price environment and uncertain demand outlook. The Board of Royal Dutch Shell has taken the decision to reset its dividend to provide financial resilience and further flexibility to manage the uncertainty. Shell is taking the steps necessary to ensure that we are well-positioned for the eventual economic recovery.

The CEO stated:

Under extremely challenging conditions, Shell is stepping up to protect our people and support communities around the globe while delivering strong safety and operational performance across our business. Our Integrated Gas and Marketing businesses continued to achieve robust results this quarter, bringing resilience to our cash flows. In March, we took decisive actions to reduce our spending, increase our liquidity and position our business to manage the deteriorating macroeconomic and commodity price outlook. Our integrated business model, the high quality of our assets and the resourcefulness of our people have allowed us to respond swiftly. Given the continued deterioration in the macroeconomic outlook and the significant mid and long-term uncertainty, we are taking further prudent steps to bolster our resilience, underpin the strength of our balance sheet and support the long-term value creation of Shell. Starting this quarter, the Board has decided to reduce our quarterly dividend to 16 US cents per share.

The Chairman of the Board commented:

Shareholder returns are a fundamental part of Shell’s financial framework. However, given the risk of a prolonged period of economic uncertainty, weaker commodity prices, higher volatility and uncertain demand outlook, the Board believes that maintaining the current level of shareholder distributions is not prudent. Following the announcement not to continue with the next tranche of the share buyback programme, the Board has also decided to reduce the first quarter 2020 dividend and reset to 16 US cents per share. As conditions allow, the Board will continue to evaluate our capital allocation priorities between ongoing investment in our business, maintaining a strong balance sheet and increasing returns to shareholders which remains our ambition.

Shell’s Dividend Cut, This Time Was Different

Considering the history of Shell’s dividend, it was probably a surprise to most large and small investors that the dividend was cut. An 80 year stretch without a cut is one that few companies can match. Additionally, Shell largely navigated the Great Recession in 2008 – 2009 and the decline in oil prices from 2015 – 2016 fairly well. Shell’s dividend was not cut during either of those time periods. Rather the dividend was increased during the Great Recession and maintained flat during 2015 – 2016.

However, demand likely dropped like a brick due to the global impact of the coronavirus. Most airlines are flying at a very limited capacity due to severely reduced demand. Cruise lines have suspended operations. ‘Social distancing’ restrictions have led to a large surge in teleworking resulting in low use of vehicles. Demand was so low oil that for the first time the prices for West Texas Intermediate or ‘WTI’ were negative. Price for Brent crude oil also dropped dramatically. In the end, the lack of demand compounded by oil price wars between Russia and Saudi Arabia probably led to very difficult operating conditions. Essentially, this time was different than in 2008 – 2009 and 2015 – 2016. In the end, Shell had a historic dividend cut.

Shell’s New Dividend Safety

The new dividend is much safer from the perspective of earnings and cash flow. It is clear that 2020 will be an atypical year with demand suppressed worldwide Let’s make the assumption that 2021 will be similar to 2017 from the perspective of oil prices and demand. In this case, diluted earnings per share were $1.56 for the regular RDS A shares. The forward dividend on these shares is $0.64. This gives a payout ratio of 41%. This is below my threshold of 65%.

In 2017, operating cash flow was $35,650 million. Capital expenditures were $20,845 million giving free cash flow of $14,805 million. Shell has about 7.8 billion shares so the current dividend will cost about $5 billion. The dividend-to-FCF ratio is now about 34%. This is a good value and below my threshold of 70%.

From the context of dividend safety, these are much better values than before the cut. 

Final Thoughts on Shell

There is a lot of uncertainty with COVID-19. The timing of resumption of ‘normal’ operations for airlines, cruise lines, freight, cars, trains, etc. is largely unknown at this time. This is largely beyond Shell’s control. Further, oil prices are a big wild card. Demand is low. Storage facilities are full, and traders are parking oil in tankers. Essentially, the world is awash in an ocean of oil. It is unclear if OPEC and other oil producing nations will cut output and by how much. Again, Shell does not really have control over this.

There is some indication in the Chairman’s statement that Shell intends to increase shareholder returns in the future. But for now, Shell’s dividend yield is far less than other oil majors. Investors seeking income or dividend growth are probably better off looking elsewhere.

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