‘Nothing Lasts Forever’: The City Mourns Shell’s Giant Dividend

(Bloomberg) -- The unthinkable took another step toward the new normal when Royal Dutch Shell Plc, Britain’s most valuable company, reduced its payout to shareholders for the first time since at least the Second World War.

The cut is another watershed moment for an oil industry coping with tectonic shifts in global commerce even before the shock from the coronavirus pandemic and the fallout of a price war between Saudi Arabia and Russia. For yield-hungry money managers running the City of London’s pension funds, Shell’s giant dividend has provided a reliable income through decades of oil busts and financial crises. That ended on Thursday.

“Nothing lasts forever,” said Paul Jackson, global head of asset allocation research at Invesco. ‘’In the current circumstances, investors have to be prepared to see dividend cuts. Just as the value of investments can go down as well as up, so can dividends.”

Until the stunning announcement by Shell Chief Executive Officer Ben van Beurden, Shell was the biggest dividend payer in the the U.K.’s benchmark FTSE 100. Just three months ago van Beurden touted the payout as a key attraction for shareholders and said he wouldn’t cut it. The company was due to pay $15 billion this year before a reduction of about two-thirds to 16 cents a share.

“Today’s dividend cut from Shell is a clear signal of uncertainty for the energy market and the broader economy,” said Andrew McCaffery, global chief investment officer at Fidelity International in London. “It indicates that oil’s demand profile will not return to previous levels across the globe, which has wider implications beyond the energy sector.”

With the global economy plunging into its deepest slump since the Great Depression, the dividend cut was based on “quite a bleak scenario” and a “crisis of uncertainty” about energy consumption, prices and maybe even about the viability of some of its assets, Van Beurden said.

While his January comments may have lured some investors into a false sense of security, “something had to give,” said Rebecca Chesworth, senior ETF strategist at State Street Global Advisors.

The yield had surged to almost 16% in March, raising questions about its sustainability especially when oil prices have crashed so dramatically.

“A wall of worry builds when you have an unrealistically high yield,” said Leonard Klahr, who was previously head of equity income funds at a predecessor to Merian Global Investors. Even after the cut “that may still be above the market level investors stop worrying and the share price can climb back up again.”

Brent crude slumped 66% in the first quarter. It crashed to the lowest in more than two decades earlier this months, while the crude in New York slumped below zero for the first time in history on April 20. Brent has recovered in the past week as major producers start cutting output.

Shell’s own missteps, though, made the payout cut almost certain in the post-virus world. Tal Lomnitzer, senior investment manager on the Global Natural Resources Team at Janus Henderson Investors, said while the catalyst for the dividend cut was the plunge in oil prices, the “root of the problem” lies in the debt stemming from its purchase of BG Group Plc in 2016.

The Anglo-Dutch company’s shareholder returns were already looking unaffordable before the virus hit. The company said in January that it had slowed the pace of its share buyback program and was unlikely to hit its $25 billion target this year. In March, it announced the cancellation of the next tranche of purchases as the severity of the pandemic became clear.

“Shareholder returns are a fundamental part of Shell’s financial framework,” Chairman Chad Holliday said in a statement. But in the current circumstances “the board believes that maintaining the current level of shareholder distributions is not prudent.”

To be sure, Shell isn’t alone in slashing its dividend as the economy craters. Numerous banks have scrapped their payouts altogether.

“The godsend is that they are still paying a dividend, said Stephen Bailey, a fund manager at Liontrust in London. “Unlike many companies that have deferred or cancelled dividends, you are still going to get income from Shell and a quarterly one too.”

Attention will now turn to the rest of the oil industry, already falling out of favour with many investors because of the uncertainties of climate change and the energy transition.

BP Plc also changed its tone on the dividend this week: the British major left its distribution unchanged but said it would review it every quarter as its first-quarter profit slumped and leverage soared. Exxon Mobil Corp. froze its dividend for the first time in 13 years on Wednesday.

Shell’s dividend cut could also have ramifications that stretch beyond the industry as plenty of retail and institutional clients rely on the company and others like it for returns. This model of investing can cause investors to be heavily concentrated in a few industries, including in energy, introducing new risks for risk-averse investors, said John Roe, head of multi-asset funds at Legal & General Investment Management.

“When investors take too much of one risk, it’s like Russian roulette: it’s fine until it’s not,” said Roe. “For diversified investors, Shell is just a reminder of the dire oil market and the virus’s extreme effects. But if investors have been overly focused on chasing high income across their whole portfolio, it’s part of a much more of systemic issue, as lots of their holdings will have similar issues.”

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