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Shares of Royal Dutch Shell yield almost 17%! Can that be right?

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The coronavirus market crash and ensuing uncertainty has caused the stock market to sell off sharply, and for dividend yields to rise across the board. And as regular readers of the Motley Fool know, the best bargains are found precisely when there are a lot of sellers in the market. This makes the current environment perfect for value investors. 

Too good to be true?

On the other hand, as regular readers also know, an extremely high dividend yield is not always a good sign. In fact, it often signals that the market does not believe that the company in question will be able to pay the dividend that has been forecast. This is true of companies in the energy sector today more generally, and of Royal Dutch Shell (LSE: RDSB) in particular. Shares of this oil giant are currently trading down 67% from their pre-coronavirus highs, which translates to a whopping 17% dividend yield. 

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The economic impact of the virus and subsequent quarantines has led to a fall in demand for energy. In addition, oil companies have been hammered by the price war instigated by the Saudis against the Russians, which has resulted in the price of Brent crude (the global oil benchmark) to collapse to below $30 a barrel. Obviously this impacts margins for oil producers.

Reasons to be hopeful

However, I still think that Shell represents an opportunity for investors brave enough to take a contrarian stance. For one thing, Shell hasn’t cut its dividend since World War 2. Of course, the past is no guarantee of the future. But this fact does imply that management will be extremely reticent to cut. And even if the dividend were to be cut in half, that would still be a significantly higher yield than the FTSE 100 average of 6.75%.

There are also a number of reasons to believe that Saudi Arabia’s scorched earth strategy is unsustainable. The Kingdom’s break-even oil price (the price per barrel at which it can balance the budget) is around $80. This is much higher than both Russia’s (around $40) and the US shale producers that this strategy is designed to hurt the most (around $42). The Saudis could certainly run deficits for a while. But it’s not clear whether they would want to do so in the current environment, with global growth slowing dramatically. 

Sure of Shell?

That said, I don’t think that investors should buy stocks based solely on what they think will happen in the world of geopolitics. However, I do think that investors should assess the relationship between risk and reward. And in this case, there are many reasons to be bullish on Shell. The company is trading at historically low levels.

It has a decent balance sheet that will allow management to defend the dividend, for the near-to-mid term. It is a systemically important company, making it a prime candidate for government support. And its low share price means that even if dividends are suspended, management could still buy back stock at these very attractive valuations.

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Stepan Lavrouk owns no shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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