Royal Dutch Shell: My One Big Bet

| About: Royal Dutch (RDS.A)
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Summary

After reading an article about how the dividend was at risk I felt compelled to respond.

The company will go green before it cuts the dividend.

I discuss results and what the company is doing to secure the payout.

And the saga continues. After reading an article about how the dividend was at risk, for Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B), it reminded me of how I recently discussed that the company has watched its profit fall dramatically year-over-year. Makes sense considering the pain in oil prices. The company just reported its Q2 2016, and it was rough. The headline numbers drove fear of the dividend again. So what were we looking at? Well, the company saw a profit of just $200 million compared to $3.4 billion last year. Excluding special items, the company saw profit of $1.0 billion, down from $3.8 billion a year earlier. Ouch. Make no mistake, the quarter was crushed by the decline in oil, gas and liquid natural gas prices. The company of course is betting heavily on the future of natural gas. However, earnings benefited from lower operating expenses.

So about this dividend. It is the only thing keeping the stock at current levels. Shareholders would be crushed if management sliced it. Sure it makes fiscal sense. But I will put my substantial bets on management borrowing until bankruptcy court to fund it, waiting for the eventual rebound. That is my one big bet. There are no sure things, but this is where I'd be placing my chips. As far as oil. It will rebound. Might not be this year, or next, but it will. As far as near-term performance, Q2 was decidedly weak for oil. Q3 hasn't been much better, but this is temporary.

I have said time and again that the company absolutely has to control costs to survive. That is all it can do. And it must continue do it effectively. The fact that the company is earnings positive is impressive in and of itself. The company is doing everything. You may recall the necessary massive recent job cuts and exploration spending reductions. Cuts continue on both fronts It has sold a plethora of assets. More sales are on the table. Remember, what is almost a year ago now, we learned that the company was going to "pull out all the stops", according to Chief Executive Officer Ben Van Beurden in a Bloomberg article. The stops are being pulled out to protect the dividend. The company is prioritizing its cash for debt service, then dividends and then a balance between buybacks and capital investment. Tens of thousands of job cuts, spending reductions and sales of non-performing assets. The company has cut the loose fat; now it is taking a scalpel to excise fat down to the bone.

We also know that the company plans to sell off assets in and pull out of up to 10 countries. The company is following up on its plans to take action to lower costs and lower spending through asset sales and new projects. Total asset sales will amount to $30 billion for the next three years. That will fund dividends, clearly. The company pays about $14 billion a year (not counting what is issued under the Scrip Dividend Program). In terms of pulling out of other countries, Shell has identified nearly 10% of its oil and gas production for reductions. This will include leaving anywhere from five to ten countries and $6 billion to $8 billion of this planned change will impact 2016 numbers and beyond.

Bottom line here? The company is protecting its dividend. It's doing everything. We are talking about sales to raise cash, but I have also said cutting spending is absolutely key. Well, in addition to the asset sales, Shell will spend about $25 billion to $30 billion each year to improve capital efficiency, but also ensure that it is still investing in its future. It is a tough balancing act, a nearly impossible high wire walk. Too much one way or the other could result in a fall, but so far, it is managing the tides. I would be remiss if I did not mention that the company sees $4.5 billion in synergies now that it owns BG. Operational expenses continue to remain low as do the company's forecasts for spending.

If you subscribe to my thesis that the dividend will be secured, and that the company is waiting it out, then I'd be a big buyer under $50 for the B class shares (under $48.75 for A class shares) if the stock gets there. It puts the yield at almost 8%. The dividend hasn't been cut since WWII. Think of all of the oil crises we have seen in that time. Let history be your guide. While I want to add more shares at an 8% yield, at north of 7%, can you really complain?

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow.

Disclosure: I am/we are long RDS.A, RDS.B.

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.

Additional disclosure: I purchase B class shares. Reinvested dividends are paid out as A. class shares.