Dividend Investing Ideas Center
Have you ever wished for the safety of bonds, but the return potential...
“The world has changed.” Those words were recently spoken by Royal Dutch Shell (RDS-A) CEO Ben van Beurden. He was talking about the effects of the COVID-19 pandemic on the world’s energy markets and why Shell was being forced to do something it hadn’t done in nearly 75 years. And that’s to cut its dividend.
Thanks to a variety of factors, the coronavirus has simply caused the supply and demand of the world’s energy markets to become unglued. So much so that, at one point, oil futures prices had turned negative. That implied that producers were paying consumers to take their energy off their hands. While energy prices have recovered somewhat, we’re still looking at average prices per barrel at lows not seen since the first Bush administration.
Long had the larger energy firms been really immune to such crazy gyrations in oil prices. But with Shell’s cut and realization that things have changed, many oil majors could be going down the same path. And that’s not good for investors.
Use the Dividend Screener to find high-quality dividend stocks. You can even screen stocks with DARS ratings above a certain threshold.
The problem in the energy market is simply an issue with supply and demand. Thanks to efficient fracking and horizontal drilling, the world is awash in oil. At the same time, thanks to the coronavirus, lockdowns, travel restrictions, and lack of economic activity have caused demand to crater.
As a result, we’ve already seen a wave of bankruptcies, layoffs, CAPEX cuts, and other moves from the energy sector. For the oil majors, most of that has focused on suspending buybacks and cutting capital spending. But Shell has decided to take that one step further. The firm cut its quarterly dividend by 66% down to just 32 cents per share.
On the surface, the cut is puzzling. That’s because Shell’s latest earnings aren’t too bad.
For the first quarter of the year, the firm reported revenues of $60 billion. That’s still an enviable amount of sales, despite being down 28% year-over-year. More importantly, those sales actually translated into profits. RDS managed to make $2.8 billion despite the slump in prices. Better still, Shell managed to pull in $12.8 billion in free cash flows (FCFs) and adjusted FCFs of $4.7 billion. That’s amazing considering the various events that conspired during the first quarter. What’s more is that FCF more than covered its pre-cut dividend payment.
Given that Shell is still making money and covering its payout, why did it exactly cut in the first place? The answer could be in this collection of charts from the firm’s earnings slide deck.
Source: Royal Dutch Shell
You are looking at Shell’s estimated demand for various products it makes – from straight crude oil to refined goods such as jet fuel and gasoline. The key thing to look at is that none of these items come close to returning to pre-COVID-19 demand until late in 2021. That’s a very long time indeed. And it echoes similar projections by other agencies. For example, the International Energy Agency (IEA) reports that global energy demand will slump by 6% in 2020. This would be the largest contraction of demand on record and is equivalent to wiping out all the demand from India.
Shell is effectively saying that the downturn will be severe and prolonged. In fact, Shell mentioned that the second quarter will be far worse than the first in terms of earnings and cash flows. The dividend cut will allow the firm to save about $10 billion per year going forward.
Don’t forget to check the Practice Management section to learn about better ways of growing your practice and becoming more efficient.
The thing is that there’s nothing special about Shell when comparing it to Exxon (XOM), BP (BP), Total(TOT) or any of the other energy majors. Sure, they all have slight differences, but they all reported similar rapid declines in their quarterly figures. And they have reduced CAPEX, buybacks, and other costs to save cash flows.
But what Shell is saying is these traditional moves might not be enough. In addition, borrowing money to pay a dividend – which is something Chevron (CVX) and others did during the last downturn – won’t work this time. The downturn is fundamentally changing the way we conduct travel, business, etc.
And analysts are starting to agree. Energy analysts at Goldman Sachs now suggest that energy firms move to a variable dividend policy that aligns dividend payments with earnings performance, while Wood Mackenzie analyst Tom Ellacott mentioned that “Shell’s dividend cut has thrown down the gauntlet to the supermajors,” and has effectively shone a spotlight on the problems in the sector. The cat is out of the proverbial bag. CVX, TOT, BP, and XOM will pay about $41 billion in dividends this year and current moves will make that difficult if Shell proves right in its projections.
None of this is particularly great for dividend seekers. The oil majors like Exxon have long been great places to hide out in storms. After all, their size and scope allow them to fight through recession and such. Key to that was their cash flows and strong dividend histories. But with Shell cutting and the supply/demand environment still poor, those payouts are now in jeopardy. For someone in retirement, living off their dividends, that’s a huge risk to undertake.
So, what’s the answer?
Well, the time to sell might be here. Clearly, the sector is too risky to support a large position or position that forms the bulk of one’s income. Shell’s dividend was safe for the time being and they still cut to preserve the future. It’s only a matter of time before one of the other oil majors follows suite.
The bottom line is that dividend seekers need to re-evaluate why they are holding energy stocks and the dividend can’t be the main draw anymore.
Keep track of the latest additions/removals to our Best Dividend Stocks List in our News section, where we regularly publish the latest around dividend investing.