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Royal Dutch Shell - Dividend maintained, but cover rapidly vanish

Nicholas Hyett | 28 July 2016 | A A A
Royal Dutch Shell - Dividend maintained, but cover rapidly vanish

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,624.20 | Buy: 1,625.00 | Change 47.80 (3.03%)
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Royal Dutch Shell has held its interim dividend steady, at 47 cents, despite underlying earnings for the quarter falling 72% to $1.0bn. The shares fell 3.5% in morning trading.

The group saw a positive contribution to earnings from the Integrated Gas ($982m) and Downstream ($1.7bn) divisions, more than outweighing a $2bn loss in the Upstream division, which saw exceptional charges of $649m.

Oil and gas production for the second quarter was up 28% versus a year earlier, to 3,508 thousand barrels of oil equivalent a day (kboe/d). This includes a 768 kboe/d contribution from BG. Excluding the impact of divestments and other one off events production increased 30%, or 2% excluding BG.

The group continues to cut costs. Underlying operating costs, excluding identified items, fell $0.9bn, before a $1bn increase due to the consolidation of BG, and are expected to trend towards an underlying run-rate of $40bn by the end of 2016. Organic capital investment, excluding the acquisition of BG, is expected to be $29bn for FY16 compared to a combined $47bn across Shell and BG in FY14.

Excluding identified items return on average capital employed was 2.5% versus 7.6% a year previously. Cash flow from operating activities for the second quarter 2016 was $2.3 billion, which included negative working capital movements of $2.5 billion.

Gearing hit 28.1% at the end of the second quarter versus 12.7% a year earlier, with the increase largely attributable to the BG acquisition. The group raised $1bn through asset disposals in the quarter.

Our view:

Shell, in common with other oil companies, has been enjoying some respite so far this year, as oil prices have bounced from their lows. Not far enough to give much support to profits, but enough to push some of the Armageddon scenarios off the table.

The company is sticking to its previous dividend commitments. Despite around a third being paid in shares rather than cash, earnings cover for the dividend is becoming increasingly ethereal. Shell would argue that at current prices, the industry will invest so little, that future production will fall, creating a global shortage of oil that will ensure a price recovery. In the meantime, the company seems prepared to let its balance sheet take the strain.

The scale of planned reductions in operating expenses is almost unfathomable, as the group tries to preserve cash flow in the face a stubbornly low oil price, clearly there have been no sacred. Capex plans are similarly pole-axed and the group should emerge as a leaner and fitter animal at the end of it all.

Shareholders should not doubt Shell's intention to pay up. The company's commitment to the dividend is legendary, indeed half of Holland would keel over in apoplectic horror if Royal Dutch Shell ever cut the payout. The question is whether the company will have the choice. Even after cutting anything that moves, (apart from the dividend), Shell's spending plans outstrip its likely cash flows. With the prospective dividend yield now over 7% investors seem to be questioning whether the current rate of pay-out can continue.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.