Questor: the best gains can be made when prospects go from terrible to merely bad. So hold Shell
Questor share tip: hard-nosed seekers of value or income (or both) can take plenty of comfort from energy giant's unloved shares
By Russ Mould 20 July 2021 • 5:00am
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Environmental campaigners may grimace and investors who run strict environmental, social and governance screens are likely to remain indifferent, but yield-seeking portfolio builders will doubtless have been delighted to hear Royal Dutch Shell's promise earlier this month of higher cash returns to shareholders in the second half of the year.
The oil giant was already expected to be the fourth-highest individual dividend payer in cash terms in the FTSE 100 this year, chipping in some £4bn, or more than 5pc of the forecast total for the entire index, all on its own.
The company's chief executive, Ben van Beurden, is now targeting an increase in total shareholder payouts – a combination of dividends and share repurchases – to between 20pc and 30pc of operating cash flow. If such figures can be maintained, they are not something at which investors should sniff, at least from a purely financial perspective.
Remember that between 2011 and 2020 Shell paid out $105bn in dividends and distributed a further $27bn via share buybacks. At current exchange rates that is the equivalent of £96bn, or almost 95pc of the company's current market value.
Granted, the dividend was cut by more than 50pc last year but Shell has already started to nudge it higher. This supports our argument, expressed here in February, that last year's reduced payout should be affordable, given that Shell had failed to cover the new dividend level (around $5.4bn or £4bn a year) only three times in the previous decade: in 2013, when capital expenditure went through the roof, and in 2015 and 2016 when oil prices went through the floor.
Spending and oil prices remain legitimate concerns and help to explain why the shares trade on a forecast price-to-earnings ratio of barely eight even as they offer a yield of 4pc.
Shell is seeking to sell assets at a time when demand for them is not great and recycle that cash into renewable energy assets, for which competition is fierce. That sounds like a recipe for selling low, buying high and destroying shareholder value along the way, but more buoyant oil and gas prices could at least help Shell attract better offers for any hydrocarbon assets of which it wishes to dispose.
Some investors may simply take the view that such an approach, while not ideal, is the lesser evil on offer, since the alternative is that Shell finds itself with "stranded" (that is to say unwanted) oil and gas fields or risks effectively losing its licence to operate if it fails to move with the times sufficiently quickly.
Accepting the least bad option does not feel like a particularly robust investment case, although in this column's experience some of the best capital gains can be made when a company's fortunes improve from terrible to merely bad or average, as the valuation starting point is usually so beaten down.
Shell could yet fit this profile after 2020's oil price collapse and the way in which investors have rushed to embrace companies that passed their environmental, social and governance tests and dumped shares in those that did not with equal alacrity.
Second-guessing where oil prices are going to go is a mug's game as there are just too many variables to consider relating to supply and demand. The price of crude could yet retreat again and make Shell's planned transition even harder to effect by depriving it of much-needed cash flow.
Shell key facts
But analysts' consensus forecasts already price that in. Moreover, the best cure for low prices is low prices, as they stimulate demand and make alternatives look more expensive. If oil companies are actively discouraged from fresh exploration work at the same time, the world could yet find demand growth exceeding supply growth, at least in the near term, as work continues on increasing capacity from wind, solar, hydro and other alternative sources.
Again, investors with a strong ESG bent will show no interest at all but hard-nosed portfolio builders who seek income or value (or both) will like the way the shares remain unloved and the dividend looks solidly underpinned.
Shell's divis should continue to please. Hold.
Questor says: hold
Ticker: RDSB
Share price at close: £13.11
Russ Mould is investment director at AJ Bell, the stockbroker.
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