Royal Dutch Shell: Uninterrupted Dividends Since World War II

Founded in 1833, Royal Dutch Shell (RDS.B) is one of the world's largest integrated oil companies with operations in over 70 countries. In addition to exploring for and extracting crude oil, natural gas, and natural gas liquids, Royal Dutch Shell owns a number of refineries, distribution terminals, and LNG tankers.

Shell organizes its business into three operating segments:

  • Integrated Gas (44% of earnings): manages liquefied natural gas (LNG) activities, including exploring for and extracting natural gas, converting gas into LNG, and delivering LNG to end markets

  • Downstream (29% of earnings): refines crude oil to produce ready-to-use fuels like gasoline and diesel, and sells petrochemicals for industrial use

  • Upstream (26% of earnings): explores for and extracts crude oil, natural gas, and natural gas liquids

Shell is well-diversified geographically, with non-USA regions generating over 75% of the firm's $388 billion of revenue in 2018.

For tax purposes, Shell has a dual share structure, with class A and class B shares domiciled in the Netherlands and United Kingdom, respectively. While Britain doesn't withhold taxes on dividends paid to foreign investors, the Dutch government does.

As a result, U.S. investors in the class A shares face a 15% dividend withholding tax, which may be recouped through a U.S. foreign dividend withholding tax credit.

Business Analysis
Oil and gas are commodity products. Prices are set on volatile and cyclical global markets and depend on numerous factors outside of any one company's control, such as the pace of global economic growth, geopolitical conflicts, and future supply concerns.

For instance, a glut in oil from the U.S. shale boom led to the 2015 oil crash, which saw the price of oil plunge 76% from peak to trough. During that time, Shell's earnings per share fell over 50%, highlighting just how merciless the oil industry is to operate in.

It may come as a surprise then that Shell has managed to deliver an uninterrupted stream of dividend payouts since World War II (i.e. no dividend cuts). To understand Shell's story more clearly, one must zoom out to a decades-long time frame.

Over the past century, the world has witnessed exponential growth in the demand for energy. A tripling of the population and rapidly rising standards of living have given way to a remarkable five-fold increase in global energy consumption since 1950.

Unsurprisingly, Shell has thrived in this environment. Despite many sustained periods of low oil prices during its long history, the company has always come out ahead. In fact, over the past 30 years Shell has more than quadrupled its revenue from $84 billion in 1989 to over $360 billion today.

Meanwhile, the massive scale attained by Shell helps the firm operate efficiently, reinvest tens of billions each year into new production, and raise cash when needed to weather storms. Shortly after the recent oil crisis, for example, management was able to sell $40 billion of non-core assets to shore up funding for the dividend.

Shell's vertical integration is also a key advantage. In addition to selling crude oil and natural gas, the company also markets refined products like gasoline and petrochemicals (via its downstream business) that benefit from low oil prices.

So between 2014 and 2015 when the average price of Brent crude oil dropped 47% (from $99 to $52 per barrel), Shell's revenue declined just 37%. This muted response to the slide in the price of oil helped Shell remain profitable throughout the oil crisis.

In times of plenty when oil prices are relatively high, management has been careful not to overextend the firm. Shell maintains a strong balance sheet and a superb AA- credit rating from S&P, which gives Shell flexibility to borrow at low costs to finance growth projects and to even help cover the dividend during lean times.

Looking ahead, management expects that the world's consumption of energy will continue to climb far into the future as the global population marches upward and standards of living improve further, especially in developing nations.

Management's outlook is supported by the U.S. Energy Information Administration, whose models indicate that global energy consumption could increase 50% by 2050, with most of the increase in demand coming from developing nations ("non-OECD").
Source: U.S. Energy Information Administration

Shell is particularly bullish about growing energy demand in fast-growing economies like China and India, which are expected to need to import huge amounts of cheaper energy in future decades. 

To capitalize on this theme, Shell has bet big on liquefied natural gas (LNG), a market it helped pioneer in the 1960s. The company paid $53 billion to acquire BG Group in 2016, turning Shell into one of the world's largest producers of LNG and lessening the company's dependence on oil. In fact, LNG now generates nearly half of Shell's earnings. 

LNG is a more easily transportable form of natural gas that can be shipped overseas, turned back into natural gas, and then converted into heat or electricity. Management believes global demand for LNG will outpace that of natural gas and oil in order to meet the needs of developing nations which lack adequate energy resources for their economies.

The bottom line is that as long as there's a constant, growing demand for energy, Shell will likely profit due to the firm's scale, operational efficiencies, vertical integration, disciplined management team, and investments in LNG.

However, there are never any guarantees, and investors should be aware of several risks that might make Royal Dutch Shell a suboptimal investment.

Key Risks
While Shell's streak of uninterrupted dividends since World War II is laudable, the company's dividend growth history is less impressive, especially when measured up against the performance of American counterparts.

Whereas U.S. oil giants Exxon Mobil and Chevron have averaged 7% annual dividend growth over the past 20 years, Shell has grown its dividend at an average clip of just 2% per year during that period, barely keeping pace with inflation.

Furthermore, Exxon and Chevron have both rewarded shareholders with annual dividend increases for more than 30 consecutive years, with raises announced each year even during the oil crisis.

Shell, on the other hand, hasn't raised its dividend since 2014, as management has prioritized debt reduction and is contending with persistently low oil prices.

Divergence in performance aside, all oil and gas producers must grapple with poor visibility into future supply and demand. No one knows when or if fossil fuels will run out or whether renewable energy sources will eventually overtake oil and gas as the most cost-effective means of meeting the world's energy needs.

At the same time, Shell must make critical decisions about where and how much to invest in new production in order to satisfy demand decades from now. Miscalculations can lead to suboptimal returns and, in a worse case scenario, jeopardize the dividend.

Today, management is making plans based on a price of $60 per barrel of oil. However, energy prices depend on many impossible-to-predict and uncontrollable factors, and every $10 change in the price of oil is said to have a $6 billion impact on Shell's cash flow. (For context, Shell's dividend costs the firm about $15 billion each year).

In fact, estimates for the price of oil in 2050 by the U.S. Energy Information Administration range anywhere from $50 to $200 per barrel, highlighting just how difficult it is for management to plan for the future.

Meanwhile, Shell is seeking to diversify its business away from a reliance on fossil fuels by investing in renewables and power generation. Burdened by investor expectations and a reliance on oil and gas to generate profits, however, it's tough for management to make speculative bets in green energy and persevere with these investments.

Closing Thoughts on Royal Dutch Shell
Few energy companies can match Royal Dutch Shell's impressive track record of steady and rising (albeit slowly) dividends over time. The firm's integrated nature, globe-spanning diversification, and strong balance sheet mean that Shell is likely to be a steady, high-yield source of dividend income for many years to come.

That said, Exxon and Chevron are arguably superior choices in the energy sector for income investors. These U.S. oil giants have superior long-term track records of capital allocation and possess more attractive dividend growth profiles.

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