It’s easy to see why investors head for oil major Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) when they are hunting for an income stream. After all, at today’s share price of 2547p, the forward dividend yield is running at about 4.5% for 2015 and City analysts expect underlying earnings to cover the payout almost twice that year.
That’s a copper-bottomed investment proposition, right? Money in the bank. Just as our investing forefather’s chanted, “Never sell Shell!”
If only investing was that simple…
How is that dividend paid?
The thing to remember about dividends is the only thing that pays them is cash. If a company doesn’t have the cash, it can’t pay the dividend so, by extension, a company paying a dividend is showing that its cash flow cuts the mustard, right?
Wrong. Companies seem to pay dividends for all sorts of reasons, even if they don’t have enough cash coming in, and that’s exactly what Royal Dutch Shell did recently. When you look at the firm’s cash flow statement, it seems clear that Shell financed its dividends during the 2013 trading year by taking on new debt and by raiding the company piggy bank!
A combination of lower cash in-flow from operations and higher capital investment came together in 2013 to leave the company bereft of any cash flow free to use for rewarding investors. However, Shell paid out around $8,015 million in dividends anyway, along with $5,000 million for share repurchases — that other well-known investor-rewarding device.
In total, Shell’s investment in operations and shareholders came in at $14,249 more than the cash coming in during 2013, with most of that over-spend going directly to benefit shareholders. The firm financed the short fall by drawing $8,854 million from its cash coffers and taking on $5,395 million more debt.
Pedestrian dividend growth
In 2012 the firm did better, with a higher cash in-flow and lower capital expenditure allowing Shell to pay the dividends, re-purchase some of its own shares and still bank about $7,258 million, although it only paid down about $17 million of its debt. However, the fluctuating nature of capital expenditure and cash in-flow seems to be a function of the cyclicality inherent in the industry, and I think it’s the main reason that Shell has struggled to raise its dividend much in recent years:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
| Dividend (cents) | 168 | 168 | 168 | 172 | 180 |
The best dividend payers earn surplus cash every year to pay the dividend, which places those firms in a strong position to grow the level of the payout over time. Shell seems to rely on averaging returns from cash flow over several years and that two-steps-forward-one back approach strikes me as being a drag on dividend progression. After all, taking on debt and raiding the bank account is fine for one year in isolation, but what if next year’s free cash falls short too. We could see debt rising further or even a dividend cut. Whenever companies or individuals spend before earning, they expose themselves to such risks.
What now?
Royal Dutch Shell might not be the best dividend proposition on the block as it seems mired in the cyclicality of its industry and seems to struggle to generate sufficient free cash flow to keep the dividend growing.
