Investing is challenging enough even without the rules being changed on the fly. So I wasn't exactly thrilled to read the new dividend policy statement that Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B) announced Thursday on its Web site:
Royal Dutch Shell plc ("Shell") announces the cancellation of its Scrip Dividend Programme ("the Programme") with effect from the second-quarter 2014 Interim Dividend onwards. The cancellation means that the second-quarter 2014 Interim Dividend and future dividends will be settled entirely in cash, rather than offering a share-based alternative. This decision will allow for a more efficient share buy-back programme.
As was the case when HBO denied me a fourth season of Deadwood, I hate it when a programme I like is cancelled!
Whether or not one believes this is a good move that eventually will create shareholder value is immaterial to this article. The sole purpose is to discuss what this means now for Shell investors and to figure out what our next course of action should be.
A Versus B - The History
Before we look to the future, let's quickly review the multinational oil super-major's present dividend policy.
Although Royal Dutch Shell is incorporated in the United Kingdom, its tax residence is in the Netherlands. That has made for a unique, complicated dividend structure. Nevertheless, its history of increasing payouts most years and its sector-leading yield has made Shell popular among Dividend Growth Investing practitioners like me.
An investor who holds Class A shares must pay a 15% Dutch withholding tax on dividends ... unless he or she opts to take distributions in additional shares rather than cash and his or her broker belongs to the Scrip Dividend Programme. (Most major brokerages do.)
Class B shareholders are not required to pay withholding taxes because those shares are traded in London and are protected by the U.K.-U.S. tax treaty. Most RDS.B owners take dividends in cash; those who elect to reinvest distributions receive shares of RDS.A.
In recent years, RDS.B has traded at a premium, meaning A Shares have cost slightly less and have yielded slightly more. B shares closed at $82.97 Thursday for a 4.53% dividend yield; RDS.A, priced at $79.56, was yielding 4.73%.
Given that I am a "serial dripper" who reinvests dividends in every company I own, RDS.A has been a Shell of an investment ... until now.
What The Rule Change Means
Let's say that as of May 14, the first-quarter ex-dividend date, you held 100 shares of RDS.A in a brokerage that participates in the Scrip Programme. On June 26, Shell will pay 94 cents per share, so you will receive $94 worth of RDS.A. If the price then is $80, that's 1.175 new shares. Because the rules won't have changed yet, you will not face Dutch withholding tax.
If you have 100 shares of RDS.B and have instructed your broker to pay you cash, you will receive $94. If you have selected the reinvestment option, you will receive $94 worth of RDS.A. Again, those scenarios are the same as you have experienced for years.
It's the second quarter when things will get hairy.
The Scrip Programme will be history, so if you own 100 RDS.A shares on Aug. 13 (the Q2 ex-div date), you will receive $79.90 in cash - $94 minus the 15% tax. If shares are in taxable accounts, you eventually will be able to claim a dollar-for-dollar credit. However, if RDS.A is in an IRA or other tax-advantaged account, withholding can't be recovered. (RDS.B shareholders who receive cash dividends will experience no change.)
After Aug. 13, there will be no apparent advantage in owning RDS.A rather than RDS.B. Indeed, those holding RDS.A in their IRAs will suffer a major income hit.
The biggest positive (and perhaps the only positive) to come out of Shell's rule change: We no longer need to debate here on Seeking Alpha which share class is the best. It's B ... by a mile.
Over the nearly two years my wife has had RDS.A in her Roth IRA, it has grown into one of our largest positions, generating about 4% of the annual dividends produced by our portfolio. So we've got some pretty big decisions ahead of us.
We certainly will sell RDS.A before Aug. 13. To avoid having to make two transactions, we probably will hold off until after we receive the Q1 dividend (June 26). Still, if I determine over the coming weeks that waiting is the wrong move - maybe the company's fundamentals change or there is some other red flag - I won't hesitate. Our trading costs are low, so it would be no big deal to make a second sale after we get a few more A shares June 26.
What will we do with the proceeds of our RDS.A sale? As a DGI couple whose goal is to have a portfolio generating $3,000 in monthly dividend income by the time we're both retired, we'll have lots of "Divvy Dollars" to replace.
If we still want to own Shell and receive future dividends in cash, we could turn right around and buy RDS.B in Roberta's Roth. Or we could use the money to buy other companies. Or we could build up our dry powder in anticipation of opportunities created by the major market pullback that some experts believe is just around the corner. (Of course, many of these "experts" have been forecasting a correction for two-plus years.)
As I sit here today, I think we'll buy some RDS.B, though our stake probably will be much smaller than our current RDS.A position. We might use some of the cash to strengthen our other Big Oil holdings - Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP).
Still another possibility: investing in one of the deepwater drillers I've been considering, Ensco (NYSE:ESV) or Seadrill (NYSE:SDRL). I've been reluctant - partly because some observers have projected rough seas in the sector short-term, but mostly because we already have so much invested in energy. XOM and CVX are core holdings, COP is a top satellite and we also own fairly significant stakes in two Kinder Morgan (NYSE:KMI)(NYSE:KMR) entities. With our Shell position reduced, it might open the door a crack for ESV and/or SDRL.
Finally, we could use money from the RDS.A sale to buy non-energy companies. I have a long watch list, although most names on it are currently overvalued.
While Shell's announcement was unexpected, it's not all that unusual for rules to be changed and shareholders to be affected. Sometimes, corporations make major strategy shifts. Sometimes, federal, state and local governments amend tax policy or revamp regulations.
Shell's move demonstrates yet again why DGI proponents use the term "buy-and-monitor" instead of buy-and-hold.
As it turns out, RDS.A is anything but a hold-forever stock.
Disclosure: I am long RDS.A, RDS.B, COP, CVX, XOM, KMI, KMR. 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.