Buy Shell Next – For the Dividend Cuts

Both Shell and Next have seen share-price falls this week following announcements that they were slashing dividends, or ceasing them altogether.

Dividends are not the most important thing when buying a share. They are known as a distribution – and that is just what they are, giving their own money back to the shareholders. So the business owners now have more money in their pockets, but a less valuable company in their investment portfolio. It is no different from a shop owner taking some cash from their till: more cash in their wallet but less in the business. In both cases, the owners are flat, they still have the same total value.

In normal times, we believe in dividends. We like the discipline it installs into managers that the company needs to be making money. More than anything, we love the way that a dividend requires cold hard cash. Cash is hard to acquire or to fake (unless you are De La Rue perhaps?). Therefore we believe in cash much more than stated profits. Clever accountants – and that isn’t an oxymoron – can move profits up or down, backwards or forwards. Paying a dividend each year needs actual money. Again, it forces company boards to ensure that there is plenty of income.

But these are not normal times, are they? The damage already caused to the economy will not be undone instantly, and nor will battered confidence rebuild quickly. The habits of the population will have changed to more frugal and less consumptive patterns. When nobody knows how the second half of the year will develop (not even us), conserving cash makes huge sense, What is the alternative? Make a big pay-out now, but then have to return to the market in crisis later in the year, and possibly sell extra shares at what would be a lower price? That would only dilute shareholders. Better to keep hold of the funds ready for the rainy days likely to be endured. This is why we support Shell and Next after their cuts. Keep hold of our money and be ready for stormy times – or opportunities to expand. In a recession, cash is king!

Buy Shell

RDSB price over 12 months – from London Stock Exchange

Shell’s share-price has had a tough 12 months. We’d call it a rollercoaster, but that implies fun to be had. The market reaction to the dividend cut has moved Shell down into attractive buying territory.

Shell has been battered by the collapse in oil prices over the last two months. A collapse in demand and surge in supply could only end one way.

However, we believe in Adam Smith. The market will adjust. At this price, existing supplies will be reduced. New investment will not happen. These two factors will reduce supply over the coming months. On the demand side, things can only get better – and a low low oil price will be a real initiator of the recovery we foresee in the global economy. Oil price shocks have been drivers of two out of the last three recessions (excluding the current one). Whilst the global economy is not as sensitive to oil price rises as in the past, lower transport and supply chain costs will stimulate demand. Falling supply and rising demand can only lead to a reverse of the crash we have just seen. When marginal oil producers have costs around $45 per barrel, the market will end up there, and most likely overshoot.

Peak-oilers are predicting that this recession will encourage moves to a fossil-fuel-free future. We do not see that. A lower oil price and general lack of spending power is more likely to see the use of oil-products rise instead of promoting transfer to more expensive and untried alternatives.

When oil prices rise – and it is when rather than if – Shell will be well-positioned to benefit. The company understands the longer-term move away from oil, and is positioning itself accordingly in to gas and renewables. The world is not going to return to the dark ages with no energy use, and when things pick up, Shell will be there to provide the energy required. At 1200.00, we rate Shell B shares a strong buy.

IMPORTANT: Please see our disclaimer. We are only commentators. Readers must review any potential share purchases or sales ideas with their special advisors before going ahead.

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