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One 5% yield I’d add and one I’d avoid in 2017

Photo: Pearson plc. Fair use.

Royal Dutch Shell (LSE: RDSB) has paid a dividend since World War Two and has long been considered a stalwart with predictable payouts. But this has changed recently as the unprecedented oil price rout sent the company reeling.

Regardless, Shell shares are up around 50% so far this year as the negative sentiment surrounding future cash flows has softened a little. This recovery has been driven by the impressive integration of BG Group, an acquisition that many felt poorly timed as it coincided with a low in oil prices.

Shell bought BG for a massive $53bn and many analysts believe that an average oil price of $60 per barrel would vindicate the transaction. I’ve been impressed with the rapid productivity improvements made by the management team and believe the low oil price environment may have helped cut the fat from the combined companies faster than expected.

Here’s what management had to say about cost cuts recently: “Our underlying operational costs in 2016 are already at an annualised run rate of $40bn, $9bn lower than Shell and BG costs in 2014.”

The company is also cutting back on capital expenditure. It’s budgeted at around $25bn next year, roughly half the combined capex of BG and Shell in 2014.

While progress is being made, the 5.3% yield is far from guaranteed. For a start, there’s no certainty that oil prices will increase soon. But they will rise at some point and the real question facing Shell is not so much if, but when, oil prices will recover.

The company may opt to cut the dividend, rather than continue to fund it through a combination of debt and disposals, if the oil price remains at its current low level level for a number of years.

That said, I own the shares and still believe the yield is most likely safe in the long run and consider the company a good choice if you’re looking to boost your income in 2017.

An educational lesson?

Education expert Pearson (LSE: PSON) has transformed its business model in recent years, disposing of The Financial Times and French media group Les Echos, instead moving towards a more digital-focused education model.

The impact of this on profits? Not great. Net income has fallen from £950m in 2011 to £823m last year. Overall sales fell 7% in the first nine months of the year, with an even larger 9% fall in the company’s key market, North America, where fewer people are enrolling in some courses due to a high employment rate.

The dividend is forecast to be barely covered by earnings next year, but I also worry about the sustainability of the new business model. In my opinion, Pearson has yet to prove the approach is viable without first incurring a lot of pain. Debt has also ballooned from £764m to £1.63bn this year, which is perhaps a little alarming.

In summary, I believe the risks facing Shell to be manageable, but Pearson’s shifting business model introduces too much uncertainty for my liking.

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Zach Coffell owns Royal Dutch Shell B shares. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.