Royal Dutch Shell (RDSB) held its much awaited 2021 Strategy Day this morning. Early market reaction does not look great, with the stock down around 2.2% as I type. The ‘B’ shares trade for 1,277p, up just over 30% since the last time the energy giant featured here back in November. We can probably pin that welcome rebound on the broader rally in stocks and oil prices during that time. That last article was, after all, published just before the positive vaccine news came out. Brent crude trades for circa $61.20 per barrel at time of writing, up around 50% on pre-vaccine-news levels.
Onwards to the 2021 Strategy Day. Many folks were understandably eager for news regarding Shell’s plan for the energy transition, so let’s start there. The firm sees itself being a “net-zero emissions energy business” by 2050, which it noted as being in line with wider society, and which obviously means less reliance on fossil fuels. Not quite so much will change in the near term – with carbon intensity seen 6-8% lower by 2023 relative to 2016. Still, it does mean that oil production here has peaked, and the firm sees it declining by 1-2% per annum through 2030. Gas share of hydrocarbon production will increase to 55% by 2030 as a result. Note that Upstream liquids production averaged 1.6m barrels per day last year.
To put some dollars onto all of this, Shell sees cash capital spending (“CapEx”) at circa $25b per annum once it reduces net debt to $65b. Upstream will constitute 25-30% of that post-2025, down from over 40% currently. The Growth pillar – including renewable energy solutions and retail service stations – takes 30-40% of the post-2025 CapEx pie. That includes a near-tenfold increase on the number of EV charge points available to drivers. Shell sees its share of cash from operations (“CFFO”) increasing by a factor of 2.5, although Upstream, Integrated Gas and Chemicals and Products will still account for 75% of post-2025 CFFO. Demand for liquefied natural gas (Integrated Gas) is seen growing at up to 4% per annum out to 2040. Chemicals (Chemicals and Products) volume is also seen growing ahead of GDP.
Capital Allocation Policy
Green energy plans aside, the company reaffirmed its capital allocation policy. Shell famously, or infamously perhaps, slashed its dividend last year. Prior to that, the entire post-war era here was marked by at least stable payouts. Those payouts usually came attached with fat yields, which then formed the crux of the investment case – the high base dividend yield typically only needing modest growth on top, basically in line with global GDP. That dynamic led to shareholder returns of circa 13.5% per annum between the late-1950s and early-2000s.
Now, Shell has announced two separate 4% dividend raises since its 66% cut last year. The most recent one will take the quarterly payout to 17.35¢ per share, equal to a current dividend yield of 3.95%. The first pillar of its capital allocation plan is for this to grow at 4% per annum. That comes alongside a near-term cash CapEx budget of $19-22b. Quick maths implies a combined 2021 dividend and CapEx bill of $24-$27b, or circa $7-$10b lower than last year’s $34b in CFFO.
Surplus free cash flow is then seen supporting the next pillar – the firm’s Aa2/AA- credit rating. Shell sees a net debt load of $65b as commensurate with that in the near term. Net debt clocked in at $75.4b at the end its fiscal 2020, down from circa $79.1b at the end of FY19. It can reach its $65b target this year judging by current oil prices and analyst estimates. CFFO sensitivity to Brent stands at $6b for each $10 per barrel movement, with gas contracts typically linked to oil marker prices.
After that, some question marks start to appear. Shell notes that its third priority is for additional shareholder distributions. That is seen raising the total level of distributions, which can include dividends and stock buybacks, to 20-30% of CFFO. Presumably that means greater than 4% annual dividend growth under mid-cycle conditions, with 4% a floor in lean years. A potential question mark on that one.
Stock buybacks appear more self-explanatory, but only at first glance. The problem with rigid CFFO-linked distributions is that Shell’s business is cyclical. That raises the prospect of share buybacks typically occurring when its stock becomes most expensive. Perhaps it means to base these CFFO-linked distributions on mid-cycle conditions, which makes more sense. In any case, the implied shareholder yield stands in the 6.5-10% region right now – with that based on a current market-cap of circa $137b, plus annual CFFO in the $45b area. Hopefully that supports the share price going forward.
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