The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.
There are a variety of ways to judge future dividends, and today I am looking at Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) to see whether the firm looks a safe bet to produce dependable payouts.
Forward dividend cover
Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:
Forward earnings per share ÷ forward dividend per share
Shell is expected to produce a dividend of 116.9p per share in 2013, according to broker estimates. With earnings per share of 274.1p forecast for this period, this provides dividend cover of 2.3 times projected earnings, above the widely-regarded security marker of 2 times.
Free cash flow
Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:
Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase
The oil behemoth registered negative free cash flow of $11.12bn in 2012, albeit down from the negative reading of $12.83bn seen in the previous year. Shell saw operating profit dip to $26.84bn last year, down markedly from $31.19bn in 2011. And capex costs rose to $32.58bn from $26.3bn, outweighing slightly more favourable depreciation and amortisation and tax readings.
This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:
Short- and long-term debts + pension liabilities – cash & cash equivalents
___________________________________________________________ x 100
Shell saw its gearing ratio fall to 13.6% from 19% in 2011. Although total debt rose to $37.75bn from $37.18bn, cash and cash equivalents jumped to $18.55bn from $11.29bn. Pension liabilities remained broadly the same. Furthermore, a rise in shareholder equity — to $189.93bn from $171bn — also brought the gearing ratio down.
Buybacks and other spare cash
Shell is currently undertaking a massive share repurchase scheme, and bought back $1.2bn worth of shares from the start of 2013 up until the end of April.
As one would expect from a natural resources play, Shell ploughs plenty of its resources into capital expenditure, and the $7.86bn spent in January-March was up from $6.46bn in the corresponding 2012 quarter. Indeed, the firm intends to devote between $120bn and $130bn up until 2015 to further capital expenditure.
Black gold primed to line shareholders’ pockets
Shell increased its dividend last year after two consecutive years of keeping the full-year payout on hold. The firm was forced to suspend payment growth after the effects of the 2008/2009 financial crisis and subsequent fall in oil prices crumpled the bottom line.
But now that Shell’s growth plan through to 2015 is in full swing, I believe that the company is in good shape to keep dividends moving higher both now and for the medium term. Indeed, I expect the firm’s heavy investment to drag earnings and thus dividends northwards.
The oil giant currently provides a yield of 5.1% for 2013, far ahead of the FTSE 100 average of 3.3%. The potential for further oil price volatility could again hamper dividend growth, but I believe that the firm is in excellent shape to weather the troubles of recent years and keep investors well rewarded.
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Woodford — head of UK Equities at Invesco Perpetual — has more than 30 years’ experience in the industry, and boasts an exceptional track record when it comes to selecting stock market stars.
> Royston does not own shares in Royal Dutch Shell.