Royal Dutch Shell (RDSB) has struggled since I last covered it back in April. At the time, the energy giant had just inflicted its first dividend cut on stockholders since the Second World War. The shares traded for around 1,285p each back then, around 10% higher than the current price of 1,170p per share.
Given the above, it would not surprise me if investors were mightily sick of this one. Stock markets have done well over the past few months considering the grim state of the pandemic-hit global economy. Not only that, but the price of oil has improved substantially over that period too. Brent crude oil traded for circa $25 per barrel back at the end of April, around $20 a barrel lower than last week’s $45 closing mark.
Anyway, the firm released financial results at the back end of last month. The company generated $6.5b in operating cash flow – excluding $4b in negative working capital movements – on the back of an average realised liquids price of just $24.30 per barrel. For 1H20 as a whole, the firm generated just under $14b in cash from operations. That was down substantially on the $22.5b generated at the same point last year. Its 1H20 realised liquids price of circa $34.75 per barrel represented a drop of around 40% year-on-year.
The dividend cut is probably still a sore point for many investors out there. Prior to that, this was seen as one of the stodgiest income names in the world. Whether that came via directly holding the company’s stock, or indirectly owning it through pension plans, an awful lot of people had exposure to this. For that reason I don’t think we can talk about Shell without first talking about the dividend.
Now, the attraction of a lower dividend in terms of the company’s financial health is clear. The 62¢ per share saved thus far in FY20 from the reduced payout equals around $4.8b in cash terms. Call it almost $10b on an annualised basis, with these figures based on 7.8b shares outstanding. The 16¢ per share quarterly payout only costs the firm around $5b per annum, which should be easy enough to cover in most operating environments.
A quick look at the balance sheet shows why this is important. With net debt currently over $77b, the firm’s gearing level is now over 30% following its $17b asset impairment charge. Allowing that ratio to balloon higher would not be commensurate with its current Aa2/AA- credit rating. This goes without saying, but debt reduction becomes a much easier proposition with an extra $10b in retained earnings each year.
The shares remain cheap. It is a sign of how beaten-down they are that they still offer a current dividend yield of over 4%. That, of course, is despite a $10b cut to the annual dividend bill.
As always with cyclical businesses, we should probably look ahead to more normal operating conditions. That means a return to generating $40b-plus in annual cashflow, which would also make the current share price a steal. It would also mean the business could cover a combined capital spending and dividend bill of $30b. Not just that, but it would still throw off circa $10b in surplus annual free cash flow too. That works out to around 100p per share – and a very attractive proposition at the current 1,170p share price.
Note that Shell would not need particularly high energy prices in order to realise this. Cash from operating activities came in at $47b last year excluding working capital movements. That came at a realised liquids price of $57.75 per barrel – not a particularly high number in the grand scheme of things. If the company sees those prices in the next few years then its stock will produce good returns from here.
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