When the Commodity Supercycle petered out in 2014, heavily indebted mining giants and small oil producers were quick to slash dividends in an attempt to bring their precariously perched balance sheets back from the brink. Yet oil majors have so far maintained sky-high payouts through a combination of cost cuts, debt and neglecting capex. But is luck about to run out for income investors interested in theShell (LSE: RDSB) 6.7% yielding dividend in 2017?
Unsurprisingly, the answer to that question hinges on what oil prices do. Theres no way for us to accurately predict where oil prices will go, but the markets lack of enthusiasm for the OPEC supply cut agreement doesnt leave me with much hope that theyll be skyrocketing.
But if prices remain around their current $50-$55/bbl range, Shells dividend is looking significantly safer than it has been over the past two years. Thats because the combination of cost-cutting, highly profitable downstream refining and trading operations mean Shells operations are still generating significant cashflow. In Q3, operations provided $8.4bn in cash when the average realised price of each barrel of oil and gas equivalent was $40.43.
Now, Shell still had to issue $8bn of new debt to cover the $2.7bn cash dividend (a further $1.1bn was paidin shares), as well as costs related to the BG acquisition and significant interest payments. But, if oil can stay at or above $55/bbl then Shell should be quite close to being free cash flow-positive for the first time in years.
That said, if oil prices dont reach this level then income investors are likely to be in for a rough ride as $78bn of net debt means a third successive year of uncovered dividends would be dangerous for Shells balance sheet. Quarter end gearing of 29.2% is rapidly approaching the upper end of managements target, so if oil prices remain depressed and asset sales are minimal then dividends will be in considerable danger of being slashed.
More cash needed?
Shells dividend isnt the only one beholden to forces outside of managements control as investors in emerging markets-focused Aberdeen Asset Management (LSE: ADN) know all too well. Fourteenstraight quarters of outflows from Aberdeens funds have led to earnings per share falling for each of the past three years. Meanwhile, a progressive dividend policy means the shares 7.68% yielding dividend are now covered only 1.07 times by earnings.
With net cash at the end of September totalling 548m and annual dividends only 280m, it would appear that management could stomach uncovered dividends in 2017. Unfortunately the situation is more complicated than it would seem. Thats because 335m of this cash is a regulator-mandated capital buffer thats set to rise to 475m in the coming year. With cash generated from operations falling 31.9% year-on-year in 2016 to 362.9m, its unlikely that Aberdeens dividend could stand another year of even worse trading performance. With US interest rates rising and emerging markets once again tanking, Im fairly bearish on Aberdeens dividend outlook in 2017.
Of course, the first thing income investors look for in their holdings is often stability, which is why I recommend checking out the Motley Fool’s free report on the company named its Top Income Share of 2016.
This company’s dividend payouts have risen over 400% over the past four years but still remain covered over three times by earnings.
To discover why the Fool’s analysts love this under-the-radar dividend star, simply follow this link for your free, no obligation copy of the report.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Aberdeen Asset Management and Royal Dutch Shell B. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.