On Thursday morning Royal Dutch Shell (RDS) released financial results covering the fourth quarter of 2019 (“4Q19”). I think it is fair to say the market reaction has not been overly positive: as I type the stock is down circa 3.4% in New York, which follows similar trading earlier on in both London and Amsterdam.
Now, the last time I covered Shell on The Compound Investor was last summer. Barrels of Brent crude oil were changing hands for around $62.30 apiece at the time. As I type Brent is currently languishing in the $58.40 per barrel area. Perhaps unsurprisingly Shell ADSs have lost around 14% of their value over the same timeframe.
In terms of the financials here are some of the headline numbers. CCS earnings excluding identified items (basically Shell lingo for normalized net income) clocked in at $2,900m for the quarter and $16,500m over 2019 as a whole. On a per-ADS basis (remember one ADS trading on the New York Stock Exchange represents two underlying ordinary shares over in Europe), Shell reported CCS earnings excluding identified items of $0.74 in 4Q19 and $4.08 for the year as a whole.
Usually when it comes to Shell most folks want to hear about one thing and one thing only: the dividend. Alongside its quarterly results announcement the oil & gas giant declared a static $0.94 per ADS quarterly cash dividend. Readers will no doubt notice that quarterly net profit came in lower than its dividend commitment in the fourth quarter. Over the year as a whole, the $4.08 per ADS that Shell made in net income just about covers its dividend obligation with a tiny amount of change left over.
The cashflow picture looks a bit better. Shell generated around $47,000m last year from all of its business lines (excluding $5,000m in negative working capital movements). After spending just under $24,000m on cash capital expenditures the company retained around $18,000m in surplus cash, of which the annual dividend took up just over $15,000m. The company also spent a further $10,000m on stock buybacks last year as part of its $25,000m buyback plan.
If you process all of those numbers you should arrive at the conclusion that Shell can afford to self fund either its current rate of dividend spending or large scale share repurchases, but not both, in the current macro environment. Obviously this excludes taking on more debt or including receipts from the sale of assets (Shell expects to raise $10,000m from this over the two-year period covering 2019 to 2020).
The Buyback Program
I’ve mentioned this previously but the $25,000m buyback program that Shell announced in 2018 makes financial sense for two reasons. (It also plans to return circa $125,000m via additional buybacks and dividend repayments in the 2021 to 2025 period). Firstly, Shell diluted its shareholders when it completed on the BG Group deal back in 2016 (because it paid part of the $53,000m purchase price by issuing fresh stock). Second, toward the end of 2017 the company cancelled its scrip dividend program (i.e. the process of paying dividends with freshly created shares instead of cash). As a result of both of these points, the annual cash dividend bill has gone through the roof in recent years.
Now, at its current stock price Shell gets to knock off nearly $70m from its annual dividend bill for every $1,000m it spends on share repurchases. The cash that gets saved then represents a recurring source of retained profit that Shell can use to the benefit of its business and stockholders. (Of course it could also just decide to bump up the per-share dividend, thereby growing its income stream (as far as shareholders are concerned) without actually spending any more cash on dividends).
Unfortunately this relies on commodity prices and trading conditions playing ball. Last year Shell realized a liquids price of $57.76 per barrel, down around 10% on the $63.85 per barrel it realized over the course of 2018. (Bear in mind that many of its gas sales contracts are also linked to the price of oil). Furthermore, its Downstream operations haven’t picked up the slack, primarily due to poor macro conditions. Shell made $15,200m last year through refining, chemicals and so on; that was down around $2,400m on 2018.
So far, I calculate that Shell has spent around 60% of the $25,000m earmarked for the stock buyback program. If the company is to complete it on schedule that means spending another $10,000m in 2020 on share repurchases. Add that to $15,000m annual dividend cash, and we would potentially be looking at another $25,000m in total 2020 shareholder returns. Just to put that figure into some context, it represents over 10% of the company’s current market capitalization.
Now, Shell also plans to spend around $24,000m on CapEx this year according to management guidance. If it is to self-fund its shareholder return plan, it would need to generate almost $50,000m in cash from operations over fiscal 2020. (Bear in mind it will also raise some money from the sale of non-core assets). Given macro conditions and Shell’s level of gearing it would not surprise me to see the buyback program delayed somewhat, but let’s see.
Shell ADSs trade for just under $54.50 apiece as I type. If math is correct that puts the stock at 13x last year’s profit with a prospective dividend yield of 6.9% based on a $3.76 annual distribution. Call me crazy but I think that is a fair deal. I mean in the current oil price environment the dividend is pretty secure. In a $60-plus oil environment, the stock starts to throw off significant levels of excess cash again. If you share my view that a $65/bbl oil price represents a reasonable long-term forward average estimate then it seems more than possible that Shell could deliver at least high single-digit annual shareholder returns.
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Disclosure: I own shares of Royal Dutch Shell PLC stock.