Shareholders in Royal Dutch Shell(LSE: RDSB) are probably aware that the oil giant pays its quarterly dividend today. Investors will receive 47 cents per share, which, if extrapolated out for the full year, equates to a mighty dividend yield of 6.4% at the current exchange rate.
That high dividend yield no doubt sounds attractive in the current low interest rate environment, however, whenever a company's yield is significantly above the market average, it's important to question whether the dividend payout is actually sustainable.
High yields can signal trouble
When a company has a dividend yield that is significantly higher than the market average, it can be a signal that the market is concerned a dividend cut may be on the horizon. The high yield is the result of many investors having already exited the stock, pushing the share price down and the dividend yield up. If the company does go on to slash its dividend, further share price declines are to be expected, and investors may be left with the nasty combination of a lower dividend payout, as well as capital losses.
Is Shell's dividend sustainable?
So can Shell afford to pay today's dividend of 47 cents per share and a dividend of $1.88 for the full year?
It's no secret that lower oil prices in the last three years have caused carnage within the oil sector. When oil was trading at the $100 mark three years ago, it was easy for companies like Shell to generate sizeable profits. However, with the oil price at $50 today, and showing few signs of a sustainable move higher, it's a different story.
For example, in FY2013 and FY2014, Shell generated earnings per share of $2.66 and $2.36 respectively. That was comfortably enough to pay its dividend of $1.80 and $1.88 during those years. However, in FY2015 and FY2016, Shell generated earnings per share of just 31 cents and 58 cents, meaning that the dividends of $1.88 the company paid out in both years, far exceeded the company's earnings. That's not sustainable in the long term.
Having said that, after examining the last two quarter's results, the picture does look to be improving a little, as the company has taken measures to improve capital efficiency and cost control.
In the first quarter of FY2017, Shell generated operating cash flow of $9.5bn, and free cash flow of $5.2bn. This enabled the company to reduce debt and cover the cash dividend payments of $3.9bn. In the second quarter, Shell generated operating cash flow of $11.3bn, and free cash flow of $12.2bn, once again covering the dividend payment of $3.9bn.
These figures suggest that to me that if oil prices stay at current levels, Shell should be able to continue to pay its current level of dividend going forward.
Consensus dividend forecasts
Nonetheless, with consensus dividend estimates for FY2017 and FY2018 currently at $1.84 and $1.83 respectively, it suggests that some analysts covering the stock believe the company will cut its dividend in the near future. Investors should be aware of this before buying for the formidable dividend yield.
Edward Sheldon owns shares in Royal Dutch Shell. 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.