Oil Rebounds, But Shell Is No Sure Thing

Questions linger over payout and BG deal

With low interest rates squeezing returns on the safest securities, fund managers are scouring the stock market for stable income streams.

So even amid plunging crude prices, the listed oil giants have been seen as meal tickets, with Royal Dutch Shell among the most generous dining companions -- as Gadfly colleague Liam Denning has illustrated.

After a 23 percent decline over the past year, the Anglo-Dutch company's shares offer a 7.5 percent dividend yield, far above the FTSE 100's 4.5 percent. That makes Shell either a bargain or a standout candidate to slash payouts. Shell's first-quarter earnings offered morsels to both camps.

Crude Awakening

Shell shares have risen as oil price recovers

Source: Bloomberg

You'd think shelling out $54 billion in cash and shares to buy BG Group in February -- shortly after oil prices reached a nadir -- might herald the dividend's demise. The BG purchase, and a previously embargoed payment to Iran, meant cash and equivalents plunged more than $20 billion in the first three months of the year to $11 billion.

Shell's balance sheet gearing (the ratio of net debt to total capital) swelled from 12.4 percent to 26.1 percent year-on-year. BG also piled $9 billion of goodwill onto Shell's balance sheet, putting pressure on the company to demonstrate it can earn back the premium paid to the fair value of BG's assets.

Balance Sheet Strain

Shell's gearing more than doubled in the first quarter following the BG deal

Source: Shell

A slump in the return on average capital employed to minus 0.4 percent from 7.1 per cent a year ago is hardly an auspicious start. 

Yet, while it didn't contribute for the full three-month period, BG still provided Shell with about $800 million in operating cash flow. Without it, Shell's $700 million in cash from operations, down 91 percent from a year ago, would have been negative. The company therefore felt comfortable paying out $3.7 billion to shareholders during the quarter.

Dwindling Cash

Shell's operating cash flows fell sharply in the first quarter but the oil major maintained the dividend

Source: Shell

Shell's CEO Ben van Beurden is doing the right things to cut costs and capex, which totaled $5.3 billion in the quarter. He said Shell would lop another $3 billion from projected capital investment this year, bringing the total down to $30 billion.

There's an argument that buying BG adds to the pressure to cut capex, which may hurt future growth -- though the positive spin is that the purchase brings more deepwater and natural gas exposure and should mean exploration needs less funding. 

The company also plans to sell about $30 billion of assets between now and 2018 to finance the BG deal, though more haste would help. Of course, it makes sense to proceed with care when oil prices are low and depress valuations. But until Shell makes progress (there were only $500 million in Q1 divestments) it leaves a question over cash flows. Indeed, it said Wednesday that the positive cash balance wouldn't continue through the year.

Oil's recent advance means shareholders are a little less pessimistic about Shell and its peers keeping on handing out the goodies. But while fund managers might wish otherwise, dividends aren't as sacred as coupons. Ultimately the payout remains a hostage to the direction of oil prices. Shell's isn't secure yet.  

    This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Chris Bryant in Frankfurt at

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    James Boxell at

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