Oil and gas supermajor Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) is one of the safest stocks around, but it isn’t immune from risk. Political problems and a fall in the price of oil could hit the firm hard, and as we’ve seen in Ukraine recently, trouble can spring up very fast.
To see whether Shell could cope with a run of bad luck without cutting its dividend, I’ve tested its financial strength using three ratios that are typically used for this purpose by credit rating agencies.
1. Operating profit/interest
Ratings agencies normally use Earnings Before Interest and Tax, instead of operating profit, but the two are normally very similar, and operating profit is easier for us to find, as it’s always included in company results.
What we’re looking for here is a ratio of at least 1.5, to show that Shell’s earnings cover its interest payments with room to spare:
$35,234m / $1642m = 21.5 times cover
It’s clear that Shell will have no problem meeting its interest repayments, which were covered 21 times by operating profits in 2013.
2. Debt/equity ratio
Commonly referred to as gearing, this is simply the ratio of interest-bearing debt to shareholder equity, or book value (total assets – total liabilities). I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.
Acceptable levels of gearing vary, but as a rule of thumb, less than 50% is pretty safe, while more than 100% is a definite risk. Between 50% and 100% is a grey area, where other factors, such as profitability and growth, need to be considered.
Shell’s net debt is $34.9bn, while its equity is $181bn, giving net gearing of 19%, which is a very safe level.
3. Operating profit/sales
This ratio is usually known as operating margin and is useful measure of a company’s profitability.
Shell’s operating margin was 7.7% in 2013, which is almost the same as that of BP and is reasonable, if unspectacular. However, the scale and diversity of Shell’s business needs to be considered — it made a 7.7% operating profit on revenues of more than $450bn!
The UK’s safest dividend?
In my view, Shell remains one of the safest dividends in the UK, and this is reflected in its AA credit rating, which is higher than all Eastern European countries, Spain, Italy and a number of other developed nations.