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Royal Dutch Shell: Unsustainable

Quad 7 Capital: Apr. 6, 2017 12:43 PM ET

Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) has been a name of controversy of late. Why? Well, this is an oil stock and oil prices have meandered. While shares are up substantially off of their multi-year lows seen a year ago, this stock still yields 7%. The dividend payment is the center of most controversy, with so many feeling it is unsustainable. That is what I keep hearing. Unsustainable. They tell me Shell is ‘unsustainable’ at $40 oil. They tell me the dividend is most certainly ‘unsustainable’ in the current climate. Some go so far as to say the entire oil industry is ‘unsustainable.’

While I agree in part with the core ideas around these statements, such as acknowledging the need for a higher oil price, recognizing the economy of the future is an all energy sources approach with investments made in renewables, I still disagree with the dividend naysayers. For those who feel oil and gas need to be left behind, the Shell CEO actually agrees with you and wants to move the industry into more diversification. In fact, the company will be raising its investment into renewables to $1 billion in annual spending by the end of the decade. Shell is out in front on this. As for the dividend, well, the dividend naysayers are right only to a point. If Shell does nothing and oil stays at current levels, that would be disaster. Make no mistake, the last year and a half has been very rough. However, the dividend with Shell is more than just about profit sharing. The dividend is the only thing keeping the stock at current levels. Shareholders would be crushed if management sliced it. Management would be rushed to the exit. This stock is a staple of millions of pensions and retirement accounts. I think folks underestimate the importance of this company to European retirement accounts. When I make these arguments the naysayers tell me “the company can’t pay out what it doesn’t have forever, it is unsustainable.” I agree.

I agree. And that is why I have been doing all I can to make you aware of the significant moves the company is making. First the company is slashing costs everywhere. We are long past cutting the fat. Now the company is being surgical. And it must continue to do it effectively. The fact that the company is earnings-positive is impressive in and of itself. The company is doing everything. Massive job cuts. Exploration spending reductions. I have also said that I think management will borrow funds until bankruptcy court to pay its dividend, waiting for the eventual rebound. As far as oil, it will rebound. Not today, not tomorrow. It might not be this year, or next, but it will. As far as near-term performance, it is going to be rough, but there are signs of hope. But what is underappreciated is the abundance of news of the company selling off assets to raise cash, all of which are dividend-protective.

We know that the company plans to sell off assets in and pull out of up to 10 countries. It is exploring sales of its Danish underground consortium stake. That could net a billion bucks or more. Let us not forget that the company also will be getting $2.2 billion from Saudi Aramco (Private:ARMCO) for a refinery breakup. The company is following up on its plans to take action to lower costs and lower spending through asset sales and new projects. It is abandoning high cost or non-profitable ventures. A prime example is the company’s plan to dismantle some Brent field production platforms in the U.K. Remember it also sold off North Sea assets with nearly $5 billion. Another example is when it dumped a petrochemical venture for just under $1 billion. And what is amazing is that these moves are already ones I have discussed in greater detail. Over the last couple weeks, we have learned of several new cash raising deals you need to be aware of.

First we learned that Shell is selling the Canadian oil sands business. This is a huge deal and one that caught me slightly by surprise. The company will sell all of its interest in Canada but also will jointly purchase Marathon Oil (NYSE:MRO) along with Canadian Natural Resources (NYSE:CNQ). This purchase will cost about $1.25 billion. However, as it offloads its stake in the Athabasca Oil Sands project, it will raise about $8.5 billion. Thus, the net proceeds from this move will be valued at around $7.25 billion.

These are just a few recent examples. Total asset sales will amount to $30 billion for the next three years. That will fund dividends, clearly. The company pays about $14 billion a year (not counting what is issued under the Scrip Dividend Program). In terms of pulling out of other countries, Shell has identified nearly 10% of its oil and gas production for reductions. This will include leaving anywhere from five to ten countries, and $6 billion to $8 billion of this planned change will impact 2016 numbers and beyond. What is more, based on revenues and cash raised, the company is covering its spending and dividends via cash flow.

Among other options the company has in its arsenal is cutting projects that won’t net the returns the company is looking for. This recently happened when Shell said it would end the development of the Prince Rupert liquefied natural gas project in British Columbia. It is not clear how much this will save but factoring in the costs of development, labor, exploration, infrastructure, etc., I think a safe assumption approaches just under a hundred million in savings longer-term. This project was picked up along with the BG acquisition. The company isn’t getting out of liquefied natural gas entirely, it still has west coast, Canadian, Australian and other projects in this space.

We learned two weeks ago that the company was also in talks with a number of buyers for its refinery in San Francisco, California. This refinery processes just under 160,000 barrels per day. One potential buyer is PBF Energy (NYSE:PBF). The pricing on this one is up in the air, with estimates ranging from $750 million to just under $1 billion. Another serious chunk of cash raised if this sale goes through.

Shell had a busy March, no doubt. One of the key deals made came two weeks ago when we discovered that Shell would sell its entire stake of its Gabon onshore interests to a subsidiary of the Carlyle Group (NASDAQ:CG). This subsidiary is going to assume debt of $385 million and will make payments up to another $150 million based on performance at the sites and based on the price of oil. Last year, these interests pumped out about 140,000 barrel equivalents per day. We can expect to see an impairment charge of $57 million for this deal when Shell reports its Q1.

Yesterday, it was released that Shell is selling its liquefied petroleum gas business in both Hong Kong and Macau to DCC Energy, an Irish company. Shell indicated that it is entering a long-term license agreement with DCC Energy to ensure the Shell brand remains visible in these Asian markets. The deal was valued at around $150 million, another strong chunk of change.

But the activity didn’t stop there. Just this morning over the wires we learned that Shell is taking big steps to get out of New Zealand. The company is selling its 50% stake in the Kapuni natural gas field to its local venture partner. Further, Shell will assume control over another joint venture company that currently operates two more gas operations in New Zealand, but Shell will be looking to offload these assets as well. While a timeline on a full exit is unclear, the company also has an 84% stake in the Maui field, and a 48% stake in the Phokura field.

So is that dividend unsustainable? Only if the company sits back and does nothing. But I think it’s pretty clear that the company means business when it comes to protecting its dividend, and keeping its word that it’s trying to unload $30 billion in assets to raise cash. While some look at earnings only, I look at the big picture, including management, history and planning. The company is protecting its dividend. Do you disagree? Submit an article today and provide data. The way I see it, the company is doing everything it can to slash costs, raise cash while simultaneously investing in its future. It is a tough balancing act, no doubt. Finally, I have said this before, but it speaks to the proud heritage of the company. Despite all the oil crises we have seen in the last 75 years, the dividend hasn’t been cut since WWII. Unsustainable? I think not.

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Disclosure: I am/we are long RDS.A, RDS.B.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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