Last year, Royal Dutch Shell (LON: RDSB) paid out dividends of $1.88 per share.
For FY2017 and FY2018 however, Shell is forecast to pay less than that. The current forecasts for these years are $1.84 and $1.83 respectively. This suggests that some analysts believe a dividend cut is likely in the near term.
Personally, barring a catastrophic oil price collapse, I don’t think Shell will cut its dividend. Here’s why.
Oil price rally
The oil price has rallied strongly from the lows of early 2016.
Currently, the price of Brent crude is just under $70 per barrel.
The oil price rise is good news for Shell and its shareholders. A higher oil price translates to higher revenues, cash flows and profits. That means less chance of a dividend cut.
Shell reduced its cost structure significantly in recent years as a result of lower oil prices. At $69 per barrel, the company should be able to generate ample free cash flow.
Free cash flow
Looking at free cash flow, it looks sufficient to cover the dividend payments.
In Q3, Shell generated operating cash flow of $7.6bn. Free cash flow was $3.7bn.
For the first nine months of the year, the figures were $28.4bn and $21.0bn. That’s a strong improvement on the first nine months of 2016, in which the figures were $11.4bn and negative $16.0bn.
Given that dividends are currently costing the company approximately $3.9bn per quarter, it appears that Shell’s free cash flow can comfortably cover the dividends for now.
Companies that have impressive dividend track records generally take great pride in these track records.
I have no doubt Shell takes pride in its own dividend history. It hasn’t cut its dividend since World War II – an outstanding achievement.
Shell won’t want to ruin that long-term track record, especially now the oil price has rebounded.
The clientele effect
Lastly, it’s worth considering the ‘clientele effect.’
Many investors buy particular stocks for key attributes. For example, income investors buy dividend stocks for their dividends.
The clientele effect is an investment theory that suggests that a stock’s price will be affected by changes in the company’s policies.
In Shell’s case, many large investors across the globe own the oil major for its stable dividend. If Shell was to cut its dividend, this could upset a few of these investors. Some may be tempted to sell the stock, pushing the share price down.
Shell most likely understands this. A dividend cut would not be in its best interests. As a result, the company is likely to do its best to maintain the dividend at the current rate for now.
Disclosure: Edward Sheldon, CFA owns shares in Royal Dutch Shell B.
This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.