Shell (LSE: RDSB) has obvious attractions as a dividend share. It currently offers a yield of 6.7%, which makes it one of the highest-yielding shares in the FTSE 100. However, there is much more to the company’s dividend appeal than simply a high yield. It could become an even more enticing income stock over the medium term.
Integration potential
Shell is in the midst of a major reorganisation. Having acquired BG Group’s assets, it is now seeking to successfully integrate them into its business. The process of integration is likely to take time and while some investors have suggested Shell has paid over the odds for the asset base, they should produce high profit and rising cash flow over the coming years.
This should enable the company to raise dividends at a rapid rate, since it is also in the process of reducing capital expenditure and exploration spend. The effect of this is likely to be that cash which would normally have been earmarked for developing the company’s asset base can instead flow to shareholders. Therefore, while the company’s outlook may be somewhat uncertain due to lower oil prices, its dividend growth prospects are exceptionally bright.
Oil industry outlook
The performance of the oil price in the last few years has been volatile to say the least. However, the supply reductions put in place by OPEC and non-OPEC countries for the first half of 2017 should allow the imbalance between demand and supply to narrow. There is also a high likelihood that the production cuts will be extended to include the second half of 2017, which may result in a supply deficit and a rising oil price.
Even if the prices of oil and gas are subdued in the coming months, in the long run they appear to have upside potential. Gas is a relatively clean fossil fuel and could therefore become increasingly popular. And while oil may be less popular in future years in the developed world, it is still expected to form a major part of the energy mix in that developing world for many years to come. Therefore, demand for oil and gas should remain robust and lead to higher profit and dividend payouts for Shell’s investors.
Valuation
As well as dividend growth potential and a high yield, Shell also offers capital growth potential. Clearly, a higher oil price could cause the company’s net profit and share price to rise. However, its current valuation also indicates that there is scope for an upward re-rating, since it trades on a forward price-to-earnings (P/E) ratio of just 12.4.
Given its size, scale and the quality of its asset base, such a low valuation seems hard to justify. When coupled with its stunning dividend potential, it means that Shell may be one of the best income shares to hold in 2017 and beyond.
