Looking for an Energy Boost? Try Royal Dutch Shell's 3.5% Dividend Yield

The energy sector, and oil companies specifically, had a particularly tough time in 2020. The industry is notorious for its cyclicality, but last year was extremely challenging -- with the Covid-19 pandemic. Commodity prices fell dramatically, leading to the integrated giants posting losses and even calling into question the storied dividend payments of many oil majors. Royal Dutch Shell was not immune, having to cut its dividend for the first time since World War II. But energy prices have recovered -- and the stock is still offering a high dividend yield of 3.5%, while the broader S&P 500 Index yields just 1.5%, on average. And with oil prices on the rise in recent weeks, Royal Dutch Shell could take a major step forward in its turnaround in 2021. Business Overview Royal Dutch Shell is one of the global big-oil supermajors, and is the second-largest behind Exxon Mobil in terms of annual production volumes. Shell is currently valued at $149 billion, also ranking second among oil companies behind Exxon Mobil by that measure. Shell is headquartered in London (UK) as well as in Den Haag (Netherlands). There are two types of shares of the company; RDS.A shares, listed in the Netherlands, and RDS.B shares, listed in the United Kingdom. In 2020, Shell cut its dividend by 66% early last year. It was the first time that it had cut the dividend since World War II. Then it raised the dividend by 4.1% in late October, just six months after the cut. The coronavirus pandemic had a significant impact on Royal Dutch Shell -- and the entire energy sector. In the fourth quarter, the company's adjusted earnings fell 86% over the prior year's quarter due to the continuing impact of the pandemic, which resulted in lower prices of oil and LNG, and poor refining margins. Shell reduced its production by 10% over the prior year's quarter. On the bright side, thanks to the aggressive production cuts of OPEC and Russia, the oil price has rallied to pre-pandemic levels. As such, we expect Shell to post $2.50 per share in profits this year. Slick Growth Prospects Since 2011, earnings-per-share declined continuously until hitting an inflection point in 2015. Earnings then increased through 2018, before falling again in 2019 and 2020. It's clear that Shell's growth will continue to be cyclical, coming in fits and starts. When oil prices were around their lows, in 2015, Shell acquired BG Group, a deep-water oil and natural gas focused upstream company, in a $53 billion deal. Shell grew its output considerably thanks to that acquisition, but output has stalled in the last four years. This is in sharp contrast to the other oil majors, such as Chevron , BP and Total , which have grown their production at a fast clip in recent years. Shell's stagnation has resulted from the natural decline of its fields and its extensive asset divestments, which helped fund the expensive acquisition. These two factors have also caused The company's reserves duration to fall for six years in a row, bringing it down to 7.9 years, which is much shorter than the average duration of the peer group (~11 years). A few months ago, Shell announced a major transformation plan, which involves a transition from oil and gas to renewable energy sources. The company will transform its refining portfolio from 14 sites to 6 energy and chemicals parks and will reduce its upstream portfolio to 9 core positions, which will generate more than 80% of the cash flows of the upstream segment. This historic transition will increase the uncertainty over future results, as the new business will probably have lower margins. On the bright side, Shell has drastically reduced its operating expenses in recent years and has invested in high-quality, low-cost reserves, which have rendered the company more profitable at a given oil price. As noted above, the OPEC and Russia production cuts have helped oil prices rebound. Moreover, bitter cold and a string of storms in the U.S. have curtailed supply in the short-term as wells have to be shut in. And the company stands to benefit from increased oil demand once the pandemic abates and travel returns toward normal. Weighing these items collectively, we are forecasting 11% annual growth over the next five years, coming off a very much subdued base for 2021. This implies the potential for $4.21 in earnings-per-share after half a decade. Dividend Safety Shell is not so much beholden to economic factors as it is to commodity prices, although certainly commodity prices are tied to economic growth over the long-term. Prior to 2020, Shell's dividend record was exceptionally solid, if not perfectly consistent. However, last year proved to be too much for the company's payout. In contrast to Exxon Mobil and Chevron, which remain Dividend Aristocrats, Shell froze its dividend for five years and cut its dividend in 2020, for the first time since World War II. Here's a look at the company's payout ratio over time: 2011: 39% 2012: 40% 2013: 69% 2014: 79% 2015: 627% 2016: 324% 2017: 98% 2018: 73% 2019: 92% 2020: 154% You can see that 2015-2016 and 2020 were particularly difficult periods. Moving forward, the new payout sits at $0.333 per quarter or $1.33 on an annualized basis. Against $2.50 in expected earnings-per-share for 2021, that works out to a current payout ratio of ~53%. Against 2018's results, the payout ratio would be around a fourth of earnings. While the dividend cut is not welcome news by current income investors, the rebased payment does allow for flexibility during leaner times. Moreover, the payout should be more secure moving forward. Valuation/Expected Return Based on the current share price near $38.30, a $0.333 quarterly dividend on $2.50 in expected EPS this year, Shell is presently trading hands with a 3.5% dividend yield, 15.3x P/E ratio and a ~53% payout ratio. As noted above, if earnings were to grow by 11% per year off 2021's low base, this would equate to $4.21 in earnings-per-share after five years. If shares were to trade at 12x earnings, this would imply a future share price of ~$51. If the dividend were to grow by 7% per year, allowing the payout ratio to decline somewhat, you would expect to collect a bit over $8 per share in cash dividends over the next five years. Adding together the potential share price and dividends, you come to a collective value of about $59, keeping in mind that this is one possibility out of many. Against the current share price, this implies the potential for 8.9% annual gains. Turning the Corner Royal Dutch Shell had previously been a very consistent income provider, with an enviable dividend record. This streak came to an end in 2020, amidst a very challenging environment. However, this alone does not mean that the security is not worthy of consideration. With the commodity environment getting much better, a 3.5% starting yield and high single-digit potential returns, Shell could be turning the corner.

Looking for an Energy Boost? Try Royal Dutch Shell's 3.5% Dividend Yield

Shell suffered along with the rest of the oil and gas sector last year. But it could be a good dividend play once again.

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