Shares in Royal Dutch Shell (LSE: RDSA)(LSE: RDSB), BP (LSE: BP) and Tate & Lyle (LSE: TATE) have all significantly underperformed the market over the past year. In part, the decline is due to market concerns over a Greek exit from the Eurozone, which has hurt equity markets globally over recent weeks.
But, these shares have lagged the FTSE 100 even before Greek concerns have had much of an impact on the market. This is because the problem with these shares stem largely from their weak underlying earnings.
So, how much further can these shares fall?
Short answer: not much.
Why? These shares have become widely judged by their dividend yields. Recent earnings volatility and expectations that earnings will eventually recover have made it far more difficult to estimate the future earnings and cash flows of these companies.
Yet even as these companies do not generate enough free cash flow to cover their capital spending needs and their dividend payments, analysts believe that their dividend policies are secure, at least in the short to medium term. Their strong underlying balance sheets should provide these companies with sufficient financial flexibility to turn around these businesses and continue to afford with their dividend payments. In addition, asset disposals from these companies will reduce the pressure to raise debt too quickly in the short term.
Shell, BP and Tate & Lyle currently yield 6.6%, 6.0% and 5.4%, respectively. Back in 2009, when Brent crude oil prices fell to $40, the dividend yields of Shell and BP briefly peaked at around 8.0% and 9.5%, respectively. But by the end of the year, both shares had dividend yields of less than 6%.
Today, the price of Brent is around $62; but more importantly, equity market valuations are far stronger and average dividend yields much lower than in the immediate aftermath of a financial crisis. So, it is unlikely that the share prices of the oil majors will fall by such a large extent that their dividend yields will reach levels seen back in 2009.
Similar to the oil majors, Tate & Lyle is suffering from lower commodity prices. Lower sugar prices and supply disruptions caused by weather and manufacturing problems led adjusted operating profits to fall by 29% this year.
However, with the company increasing its focus on the modestly growing speciality food ingredients business and lowering its cost of production, a potential turnaround is in sight. This combined with the non-cyclical nature of its food business should mean that Tate & Lyle shares deserve a lower dividend yield than the oil majors.
Unlike in 2009, when the global financial crisis reduced expectations of oil demand growth; the recent fall in the oil price is primarily due to increasing global oil supply, particularly with expanding US shale production and OPEC’s unwillingness to lose market share. This combined with the weak outlook for oil demand from emerging markets means that the low oil price will likely stay low for longer.
In conclusion, though these three shares do not seem to have much further to fall, their upside prospects are also limited because of their weak earnings outlook. The dividend income from these shares are secure over the next 3-5 years, but uncertainty over their longer term prospects will continue to put pressure on their valuations.