One dividend dud I'd sell to buy Royal Dutch Shell plc

A Shell fuel nozzle
A Shell fuel nozzle

If you were still wondering whether the oil market has truly turned a corner, then November's third-quarter results from Royal Dutch Shell (LSE: RDSB) should have been the final evidence you needed.

The group's underlying earnings for the period were 47% higher than during the third quarter last year. Free cash flow was up 10% to $3,670m. Meanwhile, net debt fell to $67.7bn from $77.8bn a year earlier.

This progress was achieved during a quarter when the average price of Brent Crude was $52, according to the firm. The average price during the final quarter of this year looks likely to be closer to $60, so I expect a further improvement in the group's year-end results.

A sneak preview

Indeed, I suspect we've already been given a sneak preview of what's to come. In a surprise strategy update at the end of November, chief executive Ben van Beurden announced plans to scrap the group's cash-saving scrip dividend (which allows shareholders to receive their dividends in shares instead of cash), and upgraded his guidance for free cash flow.

Shell now expects to generate $30bn of surplus cash by 2020, up from $25bn previously. The group even has ambitious plans to halve the net carbon footprint of its products and operations by 2050.

Why I'd buy

Analysts expect Shell to report adjusted earnings of $1.97 per share this year, rising to $2.08 per share in 2018. That puts the stock on a forecast P/E of 16, falling to a P/E of 15 next year.

This may not seem overly cheap, but it's worth noting that the oil recovery is only just getting underway. A few years ago, Shell was regularly delivering earnings of more than $2.50 per share, which would be a P/E of 12.5 at the current share price.

The other big attraction is that the forecast dividend yield of 5.8% now looks very safe to me, and has the potential for growth.

Here's what I'd sell

I rate Shell as a long-term income buy at current levels. But if you need to free up some cash to invest then one stock I'd consider selling is Africa-focused gold miner Randgold Resources (LSE: RRS).

This may seem a contrary choice, and indeed I rate Randgold as an excellent company. But in my view the group's premium valuation is becoming harder to justify. The gold market has stabilised and most gold producers are now generating healthy profits.

Even Randgold's own management seems to be acknowledging this reality. After many years during which dividends were minimal in order to provide cash for growth, the company is stepping up cash returns to shareholders.

The dividend rose by about 50% in 2016, and is expected to double this year to about $2 per share. That's equivalent to a yield of about 2.2%. Further growth is expected in 2018.

My concern here is that Randgold's advantages have been eroded by the mining crash, which forced other gold miners to become more disciplined and profitable in order to survive.

With the group's stock now trading on a 2018 forecast P/E of 23, I think there's a risk that the shares will lag the wider market, unless there's a major shift in the price of gold.

5 more dividends you could consider

Although I'm bullish about Shell, I certainly wouldn't want to build an income portfolio that was too dependent on oil and gas. That's why I'd urge you to consider some of the stocks featured in our dividend investing report, 5 Shares To Retire On.

We've handpicked these FTSE 100 dividend stocks as a result of their defensive qualities and long track records of growth. Among the companies featured are a pharma stock and a utility.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.