Will royal dutch shell plc (adr) opt for capex cuts to maintain dividends

Oil majors across the globe have given in to pressure from investors to maintain their dividends, amid the oil slump. Following the acquisition of BG, Royal Dutch Shell plc (ADR) ( NYSE:RDS. A) shareholders are pushing the oil major to bring its capital expenditure (capex) below $30 billion — to maintain its dividend payout. Last year’s declining profits amid a depressed crude environment prompted several oil companies to hold back investment plans, halt upcoming projects, and reduce workforce by a significant margin. Reduction in Capex

The independent oil and gas company, Royal Dutch Shell has attempted to reduce its capex over the past couple of years to remain profitable. In fiscal year 2014 (FY14), the company spent approximately $31.8 billion, marking a decline of 20.6% against 2013 levels.

The trend has since then persisted, as the company reported a capex of $26.13 billion in FY15, down 17.83% from last year — the lowest in more than three decades. It is expected to fall further in 2016.

Following the successful acquisition of BG and its official delisting from New York Stock Exchange, the combined entity is all set to spend $33 billion in 2016, which investors though perceive as quite high. Shell CEO Ben Van Beurden had “options on the table to further reduce our spending should conditions warrant that step.”

At $33 billion, Shell has the highest capital spending budget for 2016, compared to Exxon Mobil and Chevron Corporation at $23.20 billion and $26.50 billion, respectively. BP, on the other hand, has a budget of $18 billion.

According to the latest filing, Royal Dutch Shell has the highest debt-to-market-capitalization ratio — a measure of the debt component of the company’s capital structure — of 0.41, as compared to Chevron’s 0.23 and Exxon Mobil’s 0.12. According to Thomson Reuters, the company increased its debt by nearly 25% of its market capitalization following the BG deal, while investors and analysts expect further capex cuts and rising debt for the company, in the wake of the worst downturn ever.

Since the announcement of the deal back in April 2015, the debt-to-total market cap ratio has increased. In the second quarter, the company had a ratio of 0.3, which increased to 0.37 and 0.41 in the third and fourth quarter, respectively. If the company accumulates more debt in the next few quarters, lenders may restrict the company’s ability to invest. Shell-BG Merger

Shell’s decision to acquire BG is extremely well-timed. The deal will allow the company to rapidly increase its cash flow and overall production, given BG’s exposure in Brazil’s offshore deep-water oil fields and Australian gas facilities. For the time being, the company isn’t required to invest any time soon.

According to Bernstein research analyst, Oswald Clint, who has given an Outperform rating on the stock, Shell needs to go forth with further capex cuts if oil prices fail to recover. Mr. Clint believes the oil major may announce reduction in capex from $33 billion to $28 billion at the investor day meeting on July 7. Of the total $5 billion reduction, $2 billion could be from cost-cutting initiatives, $1 billion from reduction in exploration and $1.8 from suspension of projects.

Despite a consistent decline in net income over the past couple of months, and a massive 52.31% decline in its bottom line from 2014 levels, the company has maintained its dividend per share of $1.88 since 2013. Back then, oil prices were hovering at $100 per barrel.

It has a strong history of maintaining its dividend. Ever since the Second World War concluded in 1946, Shell has refrained from reducing its dividend. Even after the merger, Shell wishes to keep its decision unchanged. Portfolio Manager at Investec Asset Management Charles Whall believes a cut is necessary if the market wants to believe the dividend payout will be sustained. Bottom Line

With no other companies jumping on the capex cut bandwagon, Shell has a challenging task ahead. With oil prices expected to remain low, Shell requires a reduction in capex if it is to keep its income-seeking investors happy. Several companies have resorted to dividend payouts despite oil hovering at its multi-year lows. Several still took to the credit markets to maintain or increase dividends.