The calendar year 2016 is the most stressed relationship between Royal Dutch Shell’s dividend payout and current earnings that has existed since the oil crisis of 1986. That is something that catches my attention. After this morning’s post in which I discussed my hesitancy towards Ford Motor (F) stock due to the peak earnings trip, I thought it would be worthwhile to examine a company on the other side of that coin: Royal Dutch Shell.
I don’t have access to “Royal Dutch Shell: The Four Volume Set” because the last time I had the compendium it was checked out from the library, but going off of memory, I remember a passage that discussed the fact that Royal Dutch Shell had returned something outrageous like 14% annually for a century even while most analysts were downbeat on the stock. And according to Siegel’s copy of Stocks For The Long Run which I do have, Royal Dutch Shell returned nearly 13% annually from 1956 through 2003.
It’s the Rodney Dangerfield of the mega-cap universe, never quite getting its due despite earning profits somewhere between $14 billion and $31 billion in each of the past past twelve years (nothing special about the number 12–that’s just the number of reports I had time to check.) The dividend yield is usually in the 4% or 5% range, and the long-term earnings growth is usually in the 4-6% range for the long haul. Because the payout is high, and has inched upward over time, investors that own Shell and have chosen to reinvest the dividends have seen a ballooning share count over time–your share count rises, and then those additional shares pay a higher amount that can get reinvested again so that the share count climbs rapidly (giving shareholders a source of wealth that is not readily evident just by looking at a long-term stock price chart.)
The current situation for Royal Dutch Shell is troublesome for those that prize the safety of their dividends, but an opportunity for those that recognize how poor industry conditions are often synonymous with getting a good deal on the entry point. Royal Dutch Shell and BP might be the only two large-cap stocks that seem to come within hailing distance of buying General Electric and Wells Fargo during the financial crisis. To the extent there is uncertainty, you seem to be well compensated for assuming risks when the price of the stock is $38 per share.
Royal Dutch Shell passes my test of conservatism for cyclical stocks: It is expected to make $13 billion in 2016, has $31 billion in cash on hand, and only has $23 billion due within the next five years. If oil remains in the $30s and low $40s, then Shell will make $65 billion in profits over the next five years. It meets my idea of safety because it would require five years of oil the $20s for Shell to face big-picture “this business model doesn’t work and shareholders are going to face permanent impairment” problems.
What is attractive about Shell is that you have 80,000 employees doing their part to pump out or affect 1.4 million barrels of oil per day. This is a business model so strong that even at this point in the business cycle the company is still producing $35.6 million in net profits per day.
There is good reason to feel secure that Royal Dutch Shell will be around and churning out profits for a long, long time and the price of the stock today offers a very attractive entry point to capture an ownership stake in some of those profits.
Predicting a dividend is much harder, as it is a discretionary matter for the Board to decide what constitutes the best interest of the company. It’s a close call: Shell is earning just a tiny bit over $4 per share, and is committed to paying out $3.76 per share in dividends for a payout ratio of 94%. That’s tight. But it’s also one of only four non-refining oil companies in the world that is currently covering its pre-oil fall dividend payout with current earnings.
The current dividend yield is 9.89%, which is not a payout that Shell has seen in the past thirty years. It perhaps suggests that most market participants are expecting a dividend cut.
My guess is that Shell will go down one of two paths:
Maintain the dividend payout, and then be very slow giving shareholders dividend increases in the coming years. If the $3.76 dividend payout is maintained, it will only grow around 3.5% annually between now and 2026.
Or, do something drastic like cut the dividend to $0.50 quarterly or $2 annualized. If Shell goes this route, you’ll be collecting 5% instead of nearly 10%, but your future dividend growth rates will be much higher than the 3.5% rate that would be the case if the dividend was maintained. Depending on how the future of oil prices play out, I would then expect dividend growth in the 7% or so range (meaning Shell would be acting like an Exxon going forward, but of course, Exxon shareholders wouldn’t have to experience a dividend cut in order to become Exxon).
It is this messiness, or lumpiness in the potential payout, that makes many people stay away from oil stocks right now and cyclical stocks in general. As I’ve said a bunch of time, there’s nothing wrong with loading up on Colgate, Coke, and Johnson & Johnson and going through life without touching cyclicals. But the variability in payouts is a normal characteristic of European large companies, and most closely resembles the experience of being an actual owner (the American trend of anchoring a dividend payment and fighting like hell to maintain it leads to higher payouts in bad times but generally slower growth during the good years though a Shell-Exxon comparison would not illustrate this point.)
Whichever route Shell goes, I think there is a fair chance that the current price of $38 per share gives prospective owners a very good chance of collecting at least $38 per share in dividends over the next ten years. Heck, a perfectly maintained $3.76 dividend for ten years would give you $37.60, and that assumes no growth whatsoever from the core enterprise that pumps out 1.4 million barrels per day. It also ignores the rapid escalation effect of reinvested dividends, which in the case of Royal Dutch Shell, would prove substantial.
Uncertainty about dividend payouts can be a very lucrative area of the investment universe–the traditional Wall Street investor isn’t interested in Royal Dutch Shell because of its slow earnings per share growth, and traditional income investors have a strong aversion to dividend cuts. It makes sense to buy slow growers that return most of their profits to shareholders when the stock is deeply undervalued, and Shell is one such example. If it were trading at $70 or $80 like it did in 2014, I’d much rather look to Hershey, Diageo, Berkshire Hathaway, or Tiffany. But it is at $38, and that’s why it gets bumped up my list compared to companies with higher earnings growth.
The “safeness” is that the company still makes $13 billion in profits even at these low rates. That is enough to meet the debt obligations four times over. That is the fact that should give someone the confidence to own Shell for the long haul. There is uncertainty about how Shell specifically will go about delivering cash dividends to shareholders in the coming years, but the general premise that Shell will return a lot of income to shareholders (even if it comes in a lumpy form that is not a smooth annual rise) will likely bear out. If you’re not reliant on a Shell dividend to meet living expenses, and have years of patience, I think this stock is worth considering on the theory that large capital gains will eventually come and each share will eventually generate large amounts of income over the coming decade.