The Value Portfolio: Jan 23, 2018
Summary
- Royal Dutch Shell took advantage of the market downturn to acquire BG Group. That let the company grow by 50%, something that has supported production significantly.
- Royal Dutch Shell anticipates cash flow of $25-30 billion by 2020, and that could grow to almost $50 billion with recovering oil prices. That will result in significant reward to shareholders.
- I think LNG will be an especially rewarding opportunity for Royal Dutch Shell going forward. That could help the company’s cash flow to grow even further.
Royal Dutch Shell (NYSE:RDS.A) (NYSE: RDS.B) has been on a tear recently, growing to a $300 billion oil giant, making it the second-largest publicly traded oil company in the world. Yet the company isn’t done. A combination of the company’s integration of its more than $50 billion acquisition of BG Group, at an opportune time, combined with the company’s strong portfolio and its growth potential makes the company a royally good investment.
BG Group Combination
The company’s acquisition of BG Group, at a time when the oil markets were dropping, was viewed with various opinions. Many wanted the company to not issue shares when prices were low and preserve cash. However, the company paying for roughly 40% of the acquisition with cash minimized the dilution to shareholders. And it enabled the company to gain access to strong assets at a great time.
Since the acquisition, at the time of the worst period in the oil markets for the past decade, the company has managed to fully integrate BG Group. The company has used this acquisition to significant increase free cash flow while getting rid of redundant staff and divesting unnecessary assets. A big part of the company’s overall free cash flow growth is supported by the company’s BG Group acquisitions.
BG Group’s integration has come along with significant commitments to shareholders from the company. The company is committed to continuing to pay respectable dividends of almost 3%, growing shareholder distributions. At the same time, the company plans share buybacks of at least $25 billion from 2017 – 2020, a buyback that’s equivalent to almost 10% of the company’s market cap during the downturn.
More importantly, Royal Dutch Shell’s acquisition of BG Group resulted in the issuing of $30 billion of new shares, something that investors didn’t like during a downturn. Buying back $25 billion of shares means that by 2020, the effects of this acquisition, in terms of share dilution, will be fairly negligible. That means that Royal Dutch Shell managed to use the downturn to grow 50% with a net effect of very minimal dilution over five years.
Royal Dutch Shell Reduced Operating Costs With BG Group – Royal Dutch Shell Investor Presentation.
And the company’s returns from this acquisition will likely continue to grow going forward. The company plans to lower underlying operating expects and keep them lower forever. That has resulted in a more than 20% reduction in the company’s operation expenses from 2014 to 2017 saving the company $10 billion annually. The company has additional goals that should continue going forward.
As we can see, based on the company’s asset sales, size decrease, and better planning, the company has managed to significantly improve its operating expenses. This is one of the main reasons why I think the company is a great investment. Its management has shown the ability to make great decisions such as the acquisition of BG Group. That decision has rewarded investors very well even though the crash isn’t over.
Royal Dutch Shell Strong Portfolio and Growth Potential
The same efficiency and skills that have resulted in the company’s impressive integration of BG Group continue to the rest of its simply amazing portfolio and its growth potential.
Royal Dutch Shell had an 8% return on average capital employed from 2013-15 that it anticipates will grow to roughly 10% from 2019-21. That’s a 25% growth on the company’s return on capital employed that will support growing cash flow. As a result, the company anticipates that over the less than a decade period from 2013-21, the company’s organic free cash flow will grow by more than 500%.
Imagine the Royal Dutch Shell of 2021. Your investment was four years prior at just over $71 per share, an investment when the company was valued at $300 billion. Now that investment is throwing out $7 in annual cash flow with an improving gearing ratio. Out of that, the company is spending roughly $1 on buybacks annually, increasing its earnings and rewarding investors. The company also will be paying off roughly $2 per share annually in dividends.
That shows a strong commitment to shareholders that will result in mid-single digit percentage shareholder rewards for Royal Dutch Shareholders who invest today.
On top of this, the company plans to make it a goal to invest roughly $25-$30 billion in capital investment annually. That is equal to almost 10% of the company’s market cap and will support a massive increase in cash flow for the company. That growth in cash flow will continue going forward annually for investors. That means incredibly strong rewards for investors who invest today.
Looking at the company’s portfolio of projects specifically and their growth potential, these projects support the company’s cash flow growth. The company anticipates growth in production by 0.5 million barrels per day along with more than 9.5 million tons per annum of LNG production that will support the company the company’s cash flow. That growth in production means the potential for even higher cash flow as prices recover.
Royal Dutch Shell anticipates roughly $27 billion in free cash flow on $51 per barrel of oil. Given current crude prices of almost $65 per barrel WTI, that means that this combined with growing production will result in the company’s cash flow growing to almost $45 billion annually. That means a market cap to free cash flow ratio of almost 7. That’s incredibly low, rewarding investors well.
And a significant portion of Royal Dutch Shell’s assets are in areas with the potential for major oil discoveries, such as Brazil and the Gulf of Mexico. These areas could lead to multi-billion barrel oil discoveries and help Royal Dutch Shell grow even faster. And given major oil discoveries in places such as Guyana in South America, that means huge potential for the company.
This shows Royal Dutch Shell’s impressive portfolio along with its growth potential.
One other thing I think is a great opportunity for the company as an investor, that I want to take a quick look at, is the company’s dominant position in LNG supported by the company’s recent BG Group acquisitions. The company has significant capacity additions for its natural gas portfolio that will result in 50% of supply capacity growth from 2015-2020, 50% of which already is in opportunity.
In my opinion, LNG represents a huge untapped market. I anticipate that natural gas demand will grow significantly in areas like India, Africa, and Eastern Asia as they try and deal with pollution, especially in China. While natural gas isn’t a clean fuel source, it’s cleaner than coal. China already leads the market in LNG consumption, and I anticipate that lead to continue.
Already a demand gap is expected by the 2020s, and I anticipate that demand gap will be larger than what it is currently forecast. That demand gap will lead to rising prices and the potential for very significant income for Royal Dutch Shell, and one of the things that I think will support the company as a great investment.
Conclusion
Royal Dutch Shell has made a number of impressive decisions recently, as evidenced by its stock price run-up, and I think that these decisions will continue to reward the company making it a wonderful investment. The company acquired BG Group at a market downturn that has significantly supported the company’s LNG portfolio and helped the company to increase its size. The share issues from this acquisition will be bought back by 2020.
Overall, the company anticipates its cash flow to grow significantly. The company anticipates its cash flow could grow to $30 billion by 2020, maybe even $45 billion if oil prices stay where they are, which is still way below pre-crash prices. At the same time, I think the company’s cash flow could grow even faster with its LNG portfolio. Overall, that makes Royal Dutch Shell a royally good investment.
Disclosure: I am/we are long RDS.A, RDS.B.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Royal Dutch Shell conspired directly with Hitler, financed the Nazi Party, was anti-Semitic and sold out its own Dutch Jewish employees to the Nazis. Shell had a close relationship with the Nazis during and after the reign of Sir Henri Deterding, an ardent Nazi, and the founder and decades long leader of the Royal Dutch Shell Group. His burial ceremony, which had all the trappings of a state funeral, was held at his private estate in Mecklenburg, Germany. The spectacle (photographs below) included a funeral procession led by a horse drawn funeral hearse with senior Nazis officials and senior Royal Dutch Shell directors in attendance, Nazi salutes at the graveside, swastika banners on display and wreaths and personal tributes from Adolf Hitler and Reichsmarschall, Hermann Goring. Deterding was an honored associate and supporter of Hitler and a personal friend of Goring.
Deterding was the guest of Hitler during a four day summit meeting at Berchtesgaden. Sir Henri and Hitler both had ambitions on Russian oil fields. Only an honored personal guest would be rewarded with a private four day meeting at Hitler’s mountain top retreat.
IN JULY 2007, MR BILL CAMPBELL (ABOVE, A RETIRED GROUP AUDITOR OF SHELL INTERNATIONAL SENT AN EMAIL TO EVERY UK MP AND MEMBER OF THE HOUSE OF LORDS: 
MORE DETAILS:
A head-cut image of Alfred Donovan (now deceased) appears courtesy of The Wall Street Journal.
