Are Dividends Built To Last At Royal Dutch Shell Plc And National Grid plc?

Some dividends have staying power. Companies delivering enduring dividends tend to back such often-rising payouts with robust business and financial achievement.

Fragile dividends, meanwhile, arise because of weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.

How to tell the difference

Under the spotlight today, two FTSE 100 firms: Royal Dutch Shell (LSE: RDSB) the oil company and National Grid (LSE: NG) the gas and electricity transmission system operator.

These firms operate in different sectors, but they both have a high dividend yield. At the recent share price of 1402p, Royal Dutch Shell’s forward yield for 2016 is almost 9%. At 939p, National Grid’s is nearly 5% for year to March 2017.

Let’s run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.

1. Dividend record

Both firms enjoy a record of rising dividends.

Over four years both Royal Dutch Shell’s and National Grid’s dividends advanced a modest 12%.

For their dividend records, I’m scoring Royal Dutch Shell and National Grid  3/5

2. Dividend cover

Royal Dutch Shell expects its 2016 adjusted earnings to cover its dividend around once. National Grid expects cover from earnings approaching 1.4 times.

My ‘ideal’ dividend payer would cover its cash distribution with earnings at least twice.

Of course, cash pays dividends, so it’s worth digging deeper into how well, or poorly, both companies cover their dividend payouts with free cash flow.  

However, on dividend cover from earnings I’m awarding both Royal Dutch Shell and National Grid 2/5.

3. Cash flow

Dividend cover from earnings means little if cash flow doesn’t support profits.

Here are the firms’ recent records on cash flow compared to profits:

National Grid’s toll-bridge style regulated monopoly transmission business delivers rock-solid cash flow that supports profits like granite.

Meanwhile, Royal Dutch Shell’s cash flow broadly supports profits, although the fallen oil price will probably have affected the firm’s cash flow performance during 2015.

I’m scoring Royal Dutch Shell 4/5 for its cash-flow record and National Grid 5/5.

4. Debt

Interest payments on borrowed money compete with dividend payments for incoming cash flow. That’s why big debts are undesirable in dividend-led investments.

Royal Dutch Shell’s debt runs around 2.4 times the level of its annual operating profit. Meanwhile, National Grid is a big user of borrowed money, with debts running in excess of seven times the level of operating profit.

Arguably, utilities run particular types of capital-intensive businesses with stable cash flows that require, and can justify, high debt loads. That said, they would make more secure investments with lower levels of borrowed money, and National Grid’s debt load appears to be on the rise.

I’m giving Royal Dutch Shell 3/5 and National Grid 1/5.

5. Degree of cyclicality

The recent collapse in the price of oil and commodities teaches me not to become complacent about the cyclicality present in various industries. Royal Dutch Shell operates in a cyclical sector as we can see from the firms fluctuating profits and share price.

National Grid is far less cyclical. Domestically, we keep using gas and electricity no matter what the economic weather throws at us, although industrial and commercial demand can wane during economic downturns.

Royal Dutch Shell scores 2/5 for its cyclicality and National Grid 4/5.

Putting it all together

Here are the final scores for these firms:

National Grid wins this contest, but neither firm is perfect by these measures, so my search for a dividend champion continues.