Janus Henderson Investors: What now for the oil majors?

Tal Lomnitzer, Senior Investment Manager on the Global Natural Resources Team at Janus Henderson Investors

That it comes in the immediate wake of BP holding their dividend flat is an indication of how heavy was the pay-out burden facing Shell. Whilst the catalyst for the dividend cut is undoubtedly the recent decline in oil prices, the root of the problem lies in the amount Shell paid to acquire BG. Whilst no one could have foreseen the current oil market shock, a large degree of optimism was needed to believe that Shell could pay a 50% premium for BG, extract significant synergies and maintain a dividend on a significantly expanded shareholder base. 
 
The question now arises as to what the "right" yield is for the re-based dividend and who is next to cut.  Shell is trading at around 3.6% materially lower than its peers such as Eni and BP who both defended the current dividend and are trading at over 9.5% and 10% dividend yields respectively, suggesting that the market is expecting cuts at some point.  Total, which is held by the Janus Henderson Resources fund, trades at an 8% yield, looks the most defensible in our eyes, and is also pricing in the lowest oil price, alongside being perhaps the most active in the last year developing its new energy business.  A sombre thought for RDS shareholders is that if it moves closer to Total's 8% yield the shares still face downside despite the drop already seen.
 
In the resources universe the larger diversified bulk mining companies arguably represent the safest dividends with more sensible pay-out policies. In recent years they have moved to variable pay-out ratios. When times are good shareholders know they will reap outsize rewards and when times are tougher there is no surprise when the dividend comes down. For what is ultimately a cyclical business this may be a more sensible policy.
 
The debate will continue for months to come and part of that debate must include the ongoing energy transition.  Cautionary comments from Shell regarding the current crisis increasing the likelihood of peak oil demand this decade will ring in many ears.  Ripping off the band aid always hurts but if Royal Dutch Shell's move today allows more room for alternative energy investments, and facilitates a lower cost of equity, it could be just what the company needs to ensure its long term health.