Investors have been rushing to sell the Shell (LSE: RDSB) share price in the past few weeks. Sentiment towards the company has deteriorated rapidly after the business decided to slash its dividend for the first time since World War 2.
However, while this action has dented the Shell share price’s appeal as an income investment, it could have improved the group’s long-term prospects.
Shell share price value
Before the company announced its decision to reduce its annual dividend, Shell was on track to return a total of $15bn to investors this year. According to analysts, the new dividend will save the business $10bn a year. That’s a substantial figure, and it gives the company much more financial flexibility, which could be positive for the share price in the long run.
The Shell share price is currently facing several significant headwinds. For a start, the coronavirus crisis has caused hydrocarbon demand around the world to fall by around 30%. This has sent energy prices plunging to the lowest level in several decades.
The firm is also having to deal with the environmental crisis. The company has committed to reducing its carbon footprint substantially over the next few decades, an ambition that’s helped the Shell share price.
As part of this goal, management is hoping to increase the group’s involvement in the global electricity market. It’s not possible to establish the price of this initiative right now. But Shell is already promising to spend around $2bn, or 10% of its capital budget, on low-carbon initiatives.
The company has no choice in this matter. The world is moving away from dirty, polluting fuels. The business has to adapt to this new normal, or the Shell share price could suffer in the long run.
The combination of falling oil prices and rising capital spending demands present another problem for the group. Its borrowing has increased over the past 12 months.
This is yet another situation that Shell has to adapt to, or it could suffer in the long run. The business cannot continue borrowing more and more money forever. Sooner or later, creditors will start asking tough questions. That might be bad news for the Shell share price.
As such, management’s decision to cut the dividend now, rather than trying to muddle through, seems to be the right decision. It will free up billions of dollars every year to help the company reduce debt, and meet its green goals.
This could help the company grow over the long run. What’s more, the recent dividend cut leaves the Shell share price yielding around 3.6%. That’s still attractive in the current interest rate environment. The dividend also looks more sustainable.
The bottom line
All in all, while disappointing, it looks as if management’s decision to cut the dividend was the right one. Shell now has an estimated $10bn of extra cash to reinvest back into the business. This could help accelerate the company’s earnings growth and lead to capital gains over the long term.
Therefore, now could be an excellent time for long-term investors to snap up the depressed Shell share price. As the company progresses with its transformation plans for the 21st century, shareholders can also look forward to that 3.6% dividend yield.
Rupert Hargreaves owns Royal Dutch Shell. 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.