All good things come to an end, and I’m afraid this old saying is increasingly likely to apply to today’s sky-high dividend paid by Royal Dutch Shell (LSE: RDSB).
Unsure of Shell
The oil major has a proud record of raising its dividend every year since the Second World War, but that record surely can’t last much longer. Shell faces a different type of global threat these days as the after-effects of the financial crisis continue to rumble on (or even intensify), and the oil price plunges once again.
Alarm bells were ringing in January when a barrel of crude plunged to $27 but investors started to breathe more easily after Brent climbed back above $50. Perhaps they breathed a little too easily. Many stopped worrying about oil company dividends as bullish industry experts claimed oil could keep climbing to top $70 or $75 by year-end.
Glut for punishment
It didn’t last, as the oil glut has remained astonishingly stubborn, helped by the flexibility of the US shale industry, rivalry from renewables, and slowing global demand. Brent dipped to around $40 earlier this week, although it’s back to $44 at time of writing, helped by Thursday’s Bank of England stimulus splurge.
I can’t imagine oil will stay this cheap forever, with the industry canning more one than $1trn of projects to save money, and this must eventually feed through to lower supply. But I increasingly question whether the recovery can come fast enough to spare Shell management the pain and embarrassment of cutting its dividend.
Hold on tight
The company is keeping its nerve for now, holding its interim dividend steady at 47 cents at the end of July, despite posting a whacking 72% drop in underlying quarterly earnings to $1bn.
Management is fighting tooth and nail to protect the payout. It cut underlying operating costs by $0.9bn, although that must be offset against a $1bn increase due to the consolidation of BG Group, and raised another £1bn via asset disposals. Further plans for asset sales could see it dispose of as much as 10% of its production. In fact, Shell seems to be cutting just about everything, except the blessed dividend.
You have to admire its pluck, especially as earnings cover gets thin-to-non-existent at just 0.2. This means that the only way to fund the payout is through debt, which will put further strain on the balance sheet. Gearing hit 28.1% at the end of the second quarter, up from 12.7% a year earlier, largely due to the BG acquisition. Shell urgently needs stronger cash flows but that won’t happen until the oil price rises, and there’s little sign of that right now.
Following yesterday’s interest rate cut by the Bank of England, Shell’s yield of 6.23% looks even more tempting, assuming you fancy buying a company that’s currently valued at 83 times earnings (although that’s forecast to fall to 26 times). Just be warned, that dividend may be living on borrowed time.
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Harvey Jones has no position in any shares mentioned. 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.