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Some Thoughts On Royal Dutch Shell’s Dividend In 2016

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Screen Shot 2015-11-20 at 08.55.47Casey Hoerth, Casey’s Finance Journal (Blog) Nov. 25, 2015 


Shell expects substantial cost savings and capex cuts in 2016.

Dividend sustainability in 2016 will depend on Brent crude prices.

At this time, I prefer companies that can actually acquire with oil at these prices.

Back in April, I wrote that Royal Dutch Shell’s (NYSE:RDS.A) dividend, while sustainable in the short term, would be hard to maintain in the long run if crude oil prices remained as low as they were. From what we’ve seen since April, it looks as if crude indeed wants to remain lower for longer.

Just last week, Shell had its Investor Day for 2016, where the company explained its vision for the coming year. This time around, the company didn’t center its presentation on full-year cash flow guidance for 2016. That’s because crude prices have been volatile to the point of full-year guidance being less than valuable. That, in turn, makes it difficult to get a handle on dividend sustainability for next year. This article focuses on a few things important to the company’s dividend: cash flow and capital expenditures.

Investor Day

In 2016, Shell is understandably focused on a couple of things: cost and capex reductions, and the massive acquisition of global LNG powerhouse BG Group (OTCQX:BRGXF). By way of this acquisition, Shell is effectively high-grading its project backlog, and is becoming a more LNG- and deepwater-focused company. In acquiring BG, Shell got its hands on several excellent, world-class LNG projects, such as Queensland Curtis LNG in Australia and Lake Charles LNG in Texas. The company will be shifting its capital focus to BG’s comparatively high-quality NGL and deepwater assets, while taking a sharp axe to its legacy projects, many of which will not be very profitable in this pricing environment, anyway.

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As you can see, Shell is either canceling or delaying a good many of its existing capital projects. The company cancelled its Carmen Creek oil sands project, delayed investment decisions on a couple deepwater projects, and also delayed an investment decision on Browse LNG in Australia.

Shell expects to allocate about $35 billion to capital expenditure this year, down from about $45 billion back in 2013. Next year, it will allocate another $35 billion in capex, but that capital expenditure budget will include that of both Shell and BG Group. So, while capex is the same in an absolute sense, the capex cuts are actually quite substantial. In the shale, Shell has already reduced capex from $4 billion to $2 billion between 2014 and 2015. Capex in heavy oil has fallen from $2 billion to $1.7 billion over the same period.

Like most other E&Ps, Shell continues to find operational cost savings, as oil prices remain low. Its operating costs are already down 10% versus 2014. That should save around $3-4 billion this year. In addition, last quarter the company has found another $1 billion in synergies from the BG acquisition. The original estimate was for $2.5 billion, but now it’s up to $3.5 billion.

Will all this be enough to save its dividend? Maybe. That all depends on what Shell can generate in operating cash flow. Since we don’t have full-year operating cash flow guidance for 2016, it is difficult to predict the viability of the dividend next year.

What we can do, however, is look at what the company needs to generate in operational cash flow in order to pay its dividend. Shell’s dividend over the last twelve months has been $10.6 billion, plus $35 billion in expected cash flow. The company generated $34 billion in operational cash flow over the last twelve months, and BG Group generated another $4.4 billion. That means if Shell generates the same operating cash flow as it did last year, it will fall short by $7 billion next year, although additional cost savings might cut into that deficit.

Will the company be able to hobble through next year still paying its dividend, anyway? Possibly. Management plans on selling some $10 billion in non-strategic assets next year, so in our assumption above, Shell would be covered. If Brent stays down at $45 all next year, however, then things may get dicey nevertheless.

Is Shell worth buying?

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The image can be enlarged

Shell is definitely cheap right now, and if WTI recovers to $60 or $70 by midway through next year, then the upside here will be immense. That is just speculation, however, because I still don’t see much upward catalyst for crude oil right now. It might make a good speculative buy right here, but I prefer to buy names that can pay their dividends from cash flow and have the financial firepower to actually acquire down here.

For that, I must recommend Exxon Mobil (NYSE:XOM) right now, instead. As I mentioned in an earlier article, Exxon can still fund its dividend from cash flow and, over the last quarter, also acquired 47,000 acres in the Permian Basin. Shell appears to be fairing alright in this downturn, but with Exxon I’ll sleep much better at night.

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