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Royal Dutch Shell - Dividend steady, debt falling

Equity research team | 2 February 2017 | A A A
Royal Dutch Shell - Dividend steady, debt falling

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Royal Dutch Shell Plc A Shares EUR0.07

Sell: 2,347.00 | Buy: 2,347.50 | Change 17.00 (0.73%)
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Fourth quarter underlying earnings per share (EPS) at Shell fell 12% versus a year earlier, as new shares issued as part of the BG deal diluted a 14% increase in headline earnings attributable to shareholders. With full year EPS down 49%, the Q4 performance is ahead of that seen over the full year, reflecting a higher oil price. The dividend remains unchanged.

The shares rose 1.7% following the announcement.

Our View

A much improved oil price, relative to this time last year, has helped put Shell on the road to recovery. However, there's still some way to go before the group has fully climbed out of the well in which the oil price collapse left it.

Following the acquisition of BG, Shell is heavily indebted, resulting in interest payments this year of $3bn. Asset sales and an improving cash flow position mean that net debt is falling (down $4.5bn this quarter), but the group still needs to repay around $36.7bn of debt if it is to return to the level of gearing it had before the BG deal.

Converting more of its earnings into cash means that the cash portion of its dividend is now well covered by free cash flow, and should help to put minds at rest about the viability of the current dividend rate. That's impressive in itself after many commentators (ourselves included) questioned the wisdom of sticking to such a high payout rate as earnings crumbled.

There's still plenty of work to do however.

The group is only halfway through its planned asset disposals. A recent uptick in M&A activity in the sector suggests the rate of disposals is likely to pick up. The group has cut $10bn of operating costs out of the combined BG/Shell business relative to two years ago, but there is probably more to be done.

The dividend yield has contracted as confidence in the stock has grown, with the prospective yield for the next financial year currently sitting at 6.9%. However, until debt is firmly back under control the company will remain vulnerable to another fall in the oil price, which could quickly see the balance sheet placed back under the microscope.

Full year results:

Fourth quarter numbers were boosted by an improved performance in the upsteam division (oil and gas exploration and production), which returned a positive $54m result versus a $1bn loss in Q4 2015. However, performances in downstream and integrated gas were less robust, with earnings falling in both divisions.

Shell completed or agreed $15bn of divestments in 2016, putting it half way through its $30bn divestment programme. $1.7bn of assets sales were completed in the fourth quarter. Underlying costs are $10bn lower than Shell and BG combined 24 months ago.

Dividends for the full year remain unchanged, with the group pre-announcing a Q117 dividend of $0.47, in line with the previous year. Of the $15bn of dividends issued to shareholders in 2016, 35% were paid in shares. Shell's improved fourth quarter cash flow, rising 69% to $9.2bn, means that the cash portion of the dividend is more than covered by free cash.

Divestments and improved cash flow supported a fall in net debt versus the previous quarter, now standing at $73.3bn. Gearing falling from 29.2% at the 30 September 2016 to 28% at the full year. However, this still compares unfavourably with a gearing ratio of 14% in FY15, as a result of additional debt Shell took on to acquire BG.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

All yield figures are variable and not guaranteed. The information in this article is not intended to be advice or a recommendation to buy, sell or hold any investment mentioned, nor is it a research recommendation. No view is given as to the present or future value or price of any investment, and investors should form their own view in relation to any proposed investment.

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