Royal Dutch Shell slashes its dividend: what now for income investors?

Shell's dividend cut – its first since WWII – has come as a nasty surprise. And it leaves income investors wondering where to turn now. John Stepek looks at what's behind the move and what it means for you.

Yesterday, 2020 produced yet another unwelcome, unprecedented event for investors. Oil major Royal Dutch Shell – one of the most reliable dividend payers in the UK stock market – cut its dividend.

Yes, oil prices have collapsed. But that’s happened before. This, on the other hand, is the first time Shell has cut its dividend since World War II. If Shell can cut, no dividend is safe, it seems.

So where does a beleaguered income investor turn now?

What the dividend cut means for Royal Dutch Shell investors

Oil major Royal Dutch Shell finally succumbed yesterday. After decades of maintaining its dividend through thick and thin, it cut its quarterly dividend payout from $0.47 to $0.16 per share.

There is an argument to say that the market should have been pricing this in already. After all, Shell’s dividend yield was up in double-digit territory, which displays scepticism about its ability or willingness to pay.

But offsetting that was the fact that Shell had gone to great lengths to maintain the dividend in the past. And its main rival in the FTSE 100, BP, had just said that it’d keep its payout where it is for now.

So in fact, this clearly came as a bit of a nasty surprise. The share price tumbled, and has continued to do so today. (That said, if you’d bought it at the low you’d still be up about 20-odd percent).

My own view of Shell hasn’t really changed much based on this. It still doesn’t look expensive. If you own it, there’s no reason to sell.

For what it’s worth, it looks to me increasingly as if oil may be past the worst in terms of decline now. Headlines about negative oil prices and – perhaps a bit ironically – Shell cutting its dividend for the first time since World War II are exactly the sorts of events that you see at a bottom.

And Shell is probably right to bite the bullet now. I am probably more bullish than most on the medium-term outlook for oil (I don’t think electric cars will take over as quickly as hoped) but in the long run I don’t see any reason to doubt that oil will be less important than it once was.

If oil majors are serious about transforming their businesses to take account of this, then they need to start acting rather than just talking.

However, beyond Shell, there’s a bigger question. What do income investors do now?

Politics and economics dictate that there will be more dividend cuts

In the past year, Shell accounted for more than £1.50 in every £10 paid out in dividends by the entire UK stockmarket. And if it had maintained the dividend, that proportion would have risen to closer to £2 this year.

So this is brutal for UK equity income. Worse still, it would be unwise to assume that BP (or other oil internationals) will maintain their dividends now that one of their number has broken ranks.

And the dividend outlook might deteriorate even further. There are two key elements to this. One is economic – a lot of companies are going to be hit hard and they simply won’t be able to pay as much, if anything, in dividends. Shell is a good example. But the second factor is politics – for certain sectors and companies, paying a dividend in this environment just looks plain bad, whether you or I think that makes sense or not.

Banks are the most obvious example. Yes, there are economic reasons to ditch their dividend payouts as a precautionary move, but the main reason Britain’s banks aren’t paying dividends just now is because the government told them not to. They got bailed out last time, so they have to take a telling. It’s a similar story for insurers. But it’s not just financials.

Look at supermarkets for example. There’s no profit-related reason for them not to pay dividends, but they are consumer-facing, they have received a certain amount of aid from the government in the form of business rate relief (never mind that this’ll probably be clawed back at a later date), and so payouts makes for good, if financially illiterate, scandal headlines.

You can still find an income – you just need to delve deeper

A few sectors do look more resilient than others. I can’t see pharma giant GlaxoSmithKline (which I own) being criticised for continuing to pay its dividend, nor its rival AstraZeneca.

I’d also point out that, while I like dividends as a form of disciplinary tool for management (it reminds them who they’re working for), you shouldn’t get too obsessive about dividends.

If a company refrains from paying a dividend out based purely on political pressure, then the money is still there – it’s just accruing in a different format.

But there is no doubt about it – if dividends form a major part of your investment strategy, then you’re going to have to have a rethink. As fund manager Terry Smith points out in the FT, if nothing else, this crisis offers the excuse that a lot of companies need to revise and rebase their dividend payouts – in other words, cut them for the long run, not just temporarily.

That said, there are still ways to find a decent income – you just have to delve a bit deeper.

And flicking through this week’s issue of MoneyWeek magazine, I note that we’ve highlighted several investment trusts providing a decent yield that isn’t reliant on UK equities – including one that should benefit from the oil market’s recent woes.

Oh, and we also have an update on a new addition to our model investment trust portfolio. If you’re not already a subscriber, it really is a good time to sign up, You get your first six issues (plus my new ebook) absolutely free – get more details and subscribe here.

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