Dividend drought: are there any silver linings for income seekers?

We now see more sense and less panic around dividend cuts. interactive investor’s experts explain why and spot silver linings for income seekers.

An old stock market adage is ‘never sell Shell (LSE:RDSB)'. But after reducing its divided for the first time since the Second World War, it is another hammer blow for investors. But are there any silver linings for income seekers?

Richard Hunter, Head of Markets, interactive investor, comments on Shell specifically, while Rebecca O’Keeffe, Head of Investment, interactive investor, comments on income more generally. Interactive investor is also publishing a regular dividend tracker (see below).

Rebecca says: “Many companies are suspending their dividends for the right reasons.

A cut in dividends has historically been perceived by the market as a problem, and indeed companies early on in this crisis were punished (sometimes severely) for being up-front and pro-active, but sentiment has shifted somewhat over the past few weeks and we are now seeing more sense and less panic.

However, where companies have reduced or suspended their dividends, it will leave investors having to weigh up whether this represents a prudent measure designed to tide a good, solid business over a brief period of volatility and uncertainty, or whether it is a reflection of a new post-Covid-19 world and the impact that will have. 

“’Income’ can sometimes be a misnomer. It is the total return which an investor ultimately receives, and this is fundamentally what matters, so a temporary suspension or trimming of dividends may reduce ‘income’ in the short term, but it is not necessarily going to harm the long term returns from a share if it is the right thing for that company to do. 

“The key to managing your investments in extreme markets is to try and make sure that you don’t rush into reactive decisions, which often prove to be the wrong thing to do, at the wrong time and for the wrong reasons. 

“It is essential for investors to take a hands-on approach and make sure that you are happy that your portfolio has the balance you want and the risk level you are happy with. However, it does mean being measured in your approach and this is particularly relevant in respect of companies cutting dividends. Take a long-term view and make sure that where you are making changes, you are doing it for the right reasons.”

Richard commented: “The reduction of the dividend will inevitably grab the headlines, but Shell’s brave decision reflects a desire to hunker down and protect the business in the wake of a worsening global economic outlook and a highly unstable oil price.

Of course, the reduced dividend to 16c per share from a previous level of 47c, itself unchanged since 2014, will be a blow to income-seeking investors and existing shareholders, but can be seen as a positive on two levels.

“Firstly, the move is financially prudent (and understandable, given a 28% fall in revenues and a 46% drop in replacement profit), while at the same time the dividend is now at a level which the company believes to be sustainable in the future. Secondly, even at the lower revised figure, the implied dividend yield of around 3.5% (compared to the current 10%) is still likely to exceed the FTSE 100 average due to dividend cuts elsewhere. 

“In addition, the rebasing of the dividend should free up some $9 billion over the next year. At the same time Shell is looking to reduce operational and capital expenditure by a similar amount, while expected divestments will add further grist to the financial mill, all of which will create a war chest running to nearly $30 billion.

“This capital cushion is vital in the current environment, where oil in particular is in a parlous state. A toxic combination of demand destruction, with aircraft standing idle, vastly reduced travel generally and manufacturing shutdowns, alongside the issue of oversupply, to the extent that even storage of physical oil is becoming more difficult as storage space is increasingly taken, have put the oil majors on red alert.

“More positively, Shell’s record over the last few turbulent years – including a profit warning at the end of 2019 - has been one of financial housekeeping on a truly industrial scale. Its current gearing level of 29% is above its long-term target of 25%, but nonetheless compares favourably with BP, where the figure is 36%. Furthermore, this ability to streamline operations with agility and speed strengthens what is already a strong investment proposition.

“The disappointment of the dividend decision has clearly manifested itself in the share price reaction, which adds to a 46% decline over the last year, as compared to a dip of 18% for the wider FTSE 100. In relatively dark days such as these, investors will take some comfort from the fact that, even in this environment, Shell is still profitable and is paying a dividend. Some of the sheen may have been lost from the company’s relatively bombproof reputation as a core portfolio constituent, but the market consensus of the shares as a buy for the longer term should remain unaffected.”

Interactive investor Dividend Tracker

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.