According to some City analysts, between them, BP (LSE: BP) (NYSE: BP.US) Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) currently account for £1 of every £6 paid out in dividends within the UK. However, these dividend champions could be about to start offering even better returns.
You see, oil companies are well known for their impressive dividend payouts but recently, due to the rising cost of oil exploration, oil companies have seen their profits slide, putting pressure on dividend payouts and investors are now looking for change.
One of the problems that these oil majors face is the sheer size of their operations, making it hard to keep track of everything. In particular, it has been estimated that up to 30% of Shell’s assets are not currently generating a return on investment. Indeed, the figures for this estimate seem to stack up as Shell’s return on average capital employed — a key metric in the oil industry — was relatively steady at about 20% during the 2000s, but fell to 9% last year.
Further, Shell is having a problem with free cash flow, which is not growing nearly as quickly as management said it would. The company said in 2012 that it would generate $200bn of operating cash flow over the ensuing four years, so far it has only realised about $40bn a year.
BP, too, is facing falling margins at is refining, or downstream business, where profit margins have been squeezed as the shale oil boom within the US floods the market with cheap fuel. In addition, BP continues to face claims stemming from the Gulf of Mexico disaster.
However, to their credit, the management teams of both BP and Shell have realised that these returns are unsatisfactory and something needs to be done. As a result, BP and Shell are now focused on slimming down operations, looking for quality over quantity.
Shell has been divesting assets left, right and centre, with $15bn of asset sales planned, although this figure could double. The company has already sold a multitude of underperforming assets including its share of the Wheatstone LNG project in Australia for $1.1bn, a stake in one of its Brazilian offshore assets for $1bn and most recently a $2.6bn deal was signed for downstream assets within Australia. Additionally, high-cost production assets such as oil fields in Nigeria and the North Sea are on the block.
BP is also giving itself a haircut, recently announcing a further $10bn of asset sales on top of the $38bn asset disposal plan outlined after the Gulf of Mexico disaster.
Shareholders will benefit
Following these disposals it is widely believed that shareholders will reap the benefits. Specifically, BP has stated that it will use post-tax profits of disposals for share buybacks to boost earnings per share. The company has plenty of room to do this as management believes that the company will generate $31bn of cash flow this year, a 50% increase on 2011, enough to cover its capital expenditure of $24bn-$25bn as well a cumulative $5.5bn dividend payout.
Meanwhile, Shell’s cash generated from operations covers the company’s capital expenditure giving the company plenty of options of what to do with its cash from disposals. Many City analysts believe that Shell will buy back stock with the proceeds, following the same path as the company’s international peers.
> Rupert does not own any share mentioned within this article.