At the end of last year, when it looked as if OPEC was making a concerted effort to rein-in oil market oversupply, shares in Royal Dutch Shell (LSE: RDSB) charged to a 52-week high of just under 2,400p. Unfortunately, this rally didn’t last long. By the end of the first quarter, the shares had fallen by nearly 10% and have continued to slide as worries about a new oil glut have continued to grow.
The falling oil price has reignited the argument about the sustainability of Shell’s dividend payout. This debate raged last year among analysts, but management remained committed to the payout, and the company gained some relief when it issued its first-quarter results. Indeed, for Q1 2017, the company produced a profit of $3.8bn on a current cost of supply basis. Group gearing fell to 27.2% from 28% in the quarter before the receipt of about $15bn of proceeds from asset sales, which were not completed at the time the results were issued.
Falling earnings
Q1 results convinced investors that Shell’s dividend was secure once again, but in the months following, the price of oil has dropped from an average of $54.61 in the first quarter to $45.33 at the time of writing.
According to Shell’s Q1 results presentation, a plus or minus $10 per barrel move in the price of oil impacts group earnings by plus or minus $5bn. This indicates that after the recent move in the oil price, Shell could have returned to a lossmaking position.
Abandon ship
Does this mean it’s time to abandon ship in a world of sub-$50 oil? The answer to this question ultimately depends on your outlook for the oil price, but based on Shell’s Q1 performance, I wouldn’t want to make any sudden movements.
The quarter showed that when oil prices move in Shell’s favour, even by only a few dollars, the company is hugely profitable. Further, management hasn’t yet finished restructuring the group, lowering costs and selling off non-core assets, and further action on this front will only improve the company’s profit margins.
Shell has demonstrated over the past year that the company can adapt to a world where the price of oil trades below $100 a barrel, and there’s nothing to stop the company adjusting to a lower hurdle. If oil prices never go above $50 again, the company will shape itself to fit this environment. Debt reduction, asset sales, and cost cuts are likely to come before the dividend is reduced, which is great news for investors.
Hold on
With this being the case, I believe that Shell will remain a FTSE 100 dividend champion for the foreseeable future and income investors can rely on the company’s dividend payout to remain at its current level. After recent declines, shares in Shell currently support a dividend yield of 7.1%, offering the sort of income that’s almost impossible to find elsewhere.
