Is Royal Dutch Shell plc’s 7% dividend built on shaky foundations?

Bilaal Mohamed questions the sustainability of Royal Dutch Shell plc’s (LON:RDSB) legendary dividends.

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When it comes to distributing profits to shareholders, few companies can boast a record as impressive as Royal Dutch Shell (LSE: RDSB). The London-listed oil major hasn’t cut its dividend since the Second World War, and when you think of the countless economic cycles that developed nations have endured in that time, that record seems all the more remarkable.

Cost-cutting

However, the sharp fall in the oil price since the summer of 2014 has led many to question the sustainability of the group’s shareholder payouts, as underlying earnings have been significantly lower than its dividend payments. So how has Shell managed to maintain its shareholder payouts in such a low oil price environment?

Well, I think the Anglo-Dutch oil giant has played it very smart. In recent years the group has raised billions selling off lower quality assets, while embarking on a huge cost-cutting exercise, as well as reining-in some of its major investment programmes. The dividend has thus far remained unshaken, but for how long?

Difficult to ignore

Every three months investors far and wide wait with baited breath as the oil giant announces its quarterly results, along with news of its proposed dividend, and today was no different. Shareholders woke up to the news that the company had once again maintained its quarterly dividend at 47 cents per share. The market duly reacted with the share price reaching 2,135p at one point this morning, almost 4% higher than yesterday’s close.

But that wasn’t the only good news. During the first three months of the year the company’s net income rose by a staggering 631% to $3.54bn, with cash flow from operating activities climbing to $9.5bn from just $661m for the same period last year. In addition to this, the group’s CEO Ben van Beurden was keen to point out that free cash flow of $5.2bn had enabled the company to reduce debt, and cover its cash dividend for the third consecutive quarter.

Despite continuous ramblings around the affordability of Shell’s generous shareholder payouts, I personally believe that management will continue to do its utmost to keep its promise to maintain its annual dividend at $1.88. Having overcome last year’s oil price lows below $30/barrel, the FTSE 100 giant has proven that it will take the necessary steps to keep its shareholders happy. For me, Shell’s 7.2% dividend yield is simply too difficult for income seekers to ignore.

Vulnerable

Another London-listed firm whose dividend payments have been called into question in recent times is Inmarsat (LSE: ISAT). Coincidentally, the FTSE 250-listed global satellite communications provider also updated the market with results for the first three months of its financial year earlier today.

The group reported another solid performance with revenues rising 11.3% to $333.2m, and earnings (before interest, tax, depreciation, and amortisation) up 9.2% to $181.5m. But management did however acknowledge that markets remained challenging, with the outlook very difficult to predict.

Indeed, analysts are forecasting a significant 22% dip in earnings for the full year to December, leaving the shares trading on a demanding valuation of 21 times forward earnings. Furthermore, the prospective dividend yield of 5.5% may seem tempting, but current forecasts suggest that it won’t be covered by earnings, and hence could be vulnerable to a cut.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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