2015 has so far been a tough year for Royal Dutch Shell (LSE: RDSA)(LSE: RDSB). Its shares have lost 26% of their value since the start of the year, as oil prices continue their slide downwards. Underlying earnings in the first nine months of 2015 have fallen by 54% on the prior year. But, had it not been for Shell’s diversification, its bottom line would have been much worse.
Shell’s sizeable downstream operations has offset much of the slack from its upstream operations, as the volatility in commodity prices has led to a widening of its refining margins. So, although upstream earnings fell by 91% since the start of the year, the group’s overall earnings was not as bad as many pure E&P (exploration and production) companies.
Shell’s massive dividend yield of 7.5% indicates that many investors are beginning to doubt the sustainability of its dividend policy. The recent slide in its earnings has meant its free cash flows are too low to cover its ongoing capital spending, interest payments and its dividend. And, what’s worse, the outlook for “lower for longer” oil prices means this shortfall in free cash flow will persist for, at least, a few years.
Analysts say that in order to sustain its dividend policy, Shell would need to raise debt or sell more assets. In the long term, this would not be a sustainable strategy, unless commodity prices recover substantially.
However, investors may be too pessimistic about the sustainability of Shell’s dividend, since a proportion of shareholders prefer to receive their dividends in the form of newly created Shell shares, through its Scrip Dividend Programme. This scheme improves the financial flexibility of the oil major, as it reduces the burden of dividend on its cash flow.
Cairn Energy (LSE: CNE) operates in a challenging environment, as it has interests in many high-risk and high-cost locations. A sizeable proportion of its assets are in the early development stage, and so require considerable investment needs. But, fortunately, Cairn Energy is cash rich, with $725 million in the bank at the end of June this year.
Management believes this means the company is fully funded to develop its core projects up until 2017, and it is optimistic about its longer-term prospects. It expects to break-even on a free cash flow basis by 2017, which means it could sustain further exploration and development costs beyond that date.
Investing in oil service and equipment companies could be a great alternative play on the oil sector. Although oil producers are cutting capital spending, and this is leading to a reduction of new contracts available to oilfield service groups, the need to maintain stable energy production means continued investment in existing and new oil fields is necessary. Therefore, this should mean oil services shares are less volatile than the shares of oil producers.
Lamprell (LSE: LAM), an oilfield services group focused on the Middle East, is well placed to weather the low oil price environment. As capital spending on oil projects in low-cost regions remains robust even with lower oil prices, Lamprell’s outlook is much better than many of its rivals.
Trading conditions are not as bad as initially expected, and order intake has been robust during the first half of 2015. The company has a sizeable backlog of orders worth $1.2 billion, covering much of its revenues over the next two years. What’s more, valuations are cheap as its shares trade at a forward P/E of just 8.8.
In conclusion, Cairn Energy and Lamprell seem great alternative plays on the low oil price environment. But since Shell pays such a handsome dividend, you’re being well rewarded while you wait for a rebound.
