UK-Netherland energy giant Royal Dutch Shell has for decades been a fantastic investment for long term oriented dividend investors. The company has delivered returns of over 14 % annualized since 1911 and from World War II to 2020, Royal Dutch Shell has never cut its dividend.
For decades, the average dividend yield offered has been in a range of 6 to 8 % and roughly two third of the total performance came from the distributions shareholders received plus from their dividend reinvestments in a business that had the tendency to be undervalued with regard to several metrics.
Then came the COVID-19 pandemic in 2020 with global lockdowns which severely hit oil and gas consumption. In fact, demand dried up during the lockdowns across the world which kept people inside their houses and apartments.
The world was awashed with surplus production of oil, gas etc., and commodity prices in general came under huge pressure.
As we have reflected in one of our previous articles, Sometimes a Dividend Cuts is a good sign.
Cutting its shareholder distribution by two third in 2020 looked as a drastic measure taken by the Royal Dutch Shell Management, but looking at the business financials more deeply, it was a prudent measure to conserve cash and avoid over-leveragging the company.
As we all know, commodity prices recovered substantially since March 2020, Brent oil for instance has been quite steadily marching up from below USD 20 to USD around USD 80 by the end of 2021. Natural Gas prices have even showed stronger upward movements.
Royal Dutch Shell is one of the largest oil and gas producer company and a great beneficiary of the global demand recovery after the COVID-19 pandemic.
Royal Dutch Shell, one of the strongest and most diversified energy company with enviable operations in its updstream, midstream and downstream operations is facing a very nice windfall of huge additional cash flows due to higher commodity prices driven by higher demand.
In addition to that, in September 2021 Royal Dutch Shell has reached an agreement for the sale of its Permian business to ConocoPhillips, a leading shales developer in the basin, for USD 9.5 billion.
The cash proceeds from this transaction will be used to fund $7 billion in additional shareholder distributions after closing, with the remainder used for further strengthening of the balance sheet which means that Royal Dutch Shell will use around USD 2.5 Billions to pay down debts.
These distributions in the amount of USD 7 Billion will be in addition to the shareholder distributions in the range of 20-30% of cash flow from operations which in my understanding means that Royal Dutch Shell plans special dividends. Furthermore, Royal Dutch Shell has a share buyback program ongoing in the amount of USD 2 Billion for 2021 and it’s likely that the company will continue to retire own stocks.
So, at the first sight this looks like a cash rich bonanza for income investors. But let’s keep mindful.
During the commodities decline in 2020 amid the COVID-19 pandemic, Royal Dutch Shell had to cut its dividend by two third which shouldn’t bother long term oriented investors, as it offered an opportunity for the business to readjust, retain more profits, and build itself for a stronger future during the next business cycle.
But I don’t see that happening.
Now, with higher prices and additional cash inflows from asset sales, Royal Dutch Shell is announcing special dividends and share repurchase programs.
We are here not talking about a capital light business drowning in cash like Facebook, Adobe, Alphabet or Microsoft.
Royal Dutch Shell in constrast has permanent capital reinvestment needs and sits on over USD 55 Bn in debt against annual profits of around USD 8 to 12 Billion per year, depending on the commodity prices. There is very little Royal Dutch Shell can do against price fluctuation except ensuring effective and efficient operations and acting wisely with regard to capital allocations.
Royal Dutch Shell is an asset-heavy business where cash is critical. And as we all have seen, especially during downturns in the business cycle or due to sudden demand- and price shocks, oil and gas supermajors are very vulnerable.
Due to the sale of assets and after having cutting back capital expenditures for years, Royal Dutch Shell is down millions of barrels of oil and oil equivalents in proven reserves which are about 6 – 8 years worth of proven reserves. Why not using 50 % of the USD 9.5 Billion from ConocoPhilips to buy additional Natural Gas reserves and the rest in the amount of almost USD 4.75 Billion to reduce debt by around 15 % per cent.
Just thinking of the debt interests which can be saved and used to support dividend increases over time.
Let’s bear in mind that Royal Dutch Shell is facing pressure from a court in The Hague to cut carbon emissions by 45 by 2030 from 2019 levels. My guess is that the management wants to reach that goal by disposing off oil assets and focus more on natural gas production, which leads to lesss emissions.
But how will the company make up for the sold assets when reserves are falling drastically? Where is the point in buying back own stocks with money of sold assets which over time will decrease the production capability of the company? (see also article Good share repurchase programs are rare).
With higher commodity prices and improving global demand, Royal Dutch Shell at least has the possibility to benefit of massively stronger cash flows which can also be used to transform and the strengthen the business. But a well run business should act from a position of strength in any situation.
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