I’ve advocated CEO Ben van Beurden is the real deal. He’s a no-nonsense Dutchman with an eye for business simplification and efficiency; precisely what Shell needed.
Ray Merola: Aug. 11, 2017 9:55 AM ET
Summary
- In 2017, most energy stocks have under performed.
- Amidst the castaways, there’s a Super Major gem hiding in plain sight.
- It’s a turnaround story wrapped in a 6.7% dividend yield.
Of all the companies I follow, one 2Q 2017 earnings release stood out. The company blew out Street estimates. Management continued to fulfill promises to investors. Remarkably, the stock resides in 2017’s most downtrodden neighborhood: Energy.
The company is Royal Dutch Shell (RDS.A) (RDS.B).
For those that follow my work here on Seeking Alpha, I’ve been constructive on RDS shares for a long time. I’ve advocated CEO Ben van Beurden is the real deal. He’s a no-nonsense Dutchman with an eye for business simplification and efficiency; precisely what Shell needed. In 2014, Mr. van Beurden was elevated to the CEO role after an outstanding run at Shell Chemical.
Over three-a-half years into his new role, he’s not disappointed.
Looking back to 1Q 2016, Shell had just completed its BG Group acquisition. Ben van Beurden touted it. He owned the deal. The transaction was roundly criticized by many. Detractors declared, “The timing is terrible,” “Shell paid far too much,” and of course,
“The dividend is unsustainable. It must be cut!”
Some 6 quarters later, RDS stock is up 28%. The cash dividend remains at $0.94 per ADR. In mid-2015, management made a highly unusual move for a global corporation in the midst of a commodity collapse: CEO van Beurden and CFO Simon Henry promised the payout would be maintained through at least the end of 2016, despite the industry struggling with an energy commodity collapse.
Indeed, it was not reduced, and has been maintained for an additional two quarters. In August 2017, none withstanding the robust capital appreciation, Shell shares still yield about 6.7%.
Meanwhile, Royal Dutch Shell began the process of concurrently re-imagining itself and absorbing the BG Group; a company about one-quarter the size of the old Shell itself.
Let’s briefly walk through where we’ve been, and look forward to where I believe we’re heading.
From the Depths
By mid-2015, oil prices began to roll over, hitting rock bottom in 1Q 2016. In January and February 2016, Brent and WTI fell to the mid $20s. Shell closed on the BG deal around the same time.
The company borrowed big to fund the $53 billion cash-and-stock acquisition. The rock-solid balance sheet took a hit. Gearing (i.e., debt-to-capital) nearly doubled to 26% from just 14% at the end of 2015.
Shortly after the transaction closed, van Beurden made some promises:
First, he said operating costs and capital expenditures were coming down; and fast.
In late 2015, I once again advocated a position for the shares.
January 2016 marked investors’ point of maximum pain. RDS.A shares traded for under $40 each, and offered nearly a 10% dividend yield. Fortitude was required for those scaling in on the long trip down.
The underlying business hit bedrock in 1Q 2016. Shell generated only $661 million operating cash flow, or an annualized $2.6 billion. It was a pale comparison versus over $40 billion a year OCF reported in the YE 2012-2014. In 2016, cash dividends were costing the company ~$2.5 billion per quarter.
Fast-Forward to 2017
Since the close of the BG acquisition, Royal Dutch Shell has COMPLETELY absorbed the operation’s capex and opex, while reducing its own legacy costs dramatically.
Spending
Capital spending has been reduced to $25 billion from over $40 billion a year.
The go-forward capex run-rate is $25 billion to $30 billion a year. The reduction is not simply a “cut.” Shell now utilizes far more commercial discipline. The company can stretch a buck farther than years’ past.
Opex is down 20% since 2014.
For years, Shell management emphasized span. Cost containment was not a prime mover. No more. Under Ben van Beurden operating costs are down, and these are staying down. It’s a template he used successfully when heading up Shell Chemical. The energy business is notoriously cyclical; within the energy business, chemicals are cyclical on steroids.
Divestiture Program
An announced $30 billion divestiture program remains on track. About $26 billion has been closed, is pending closure, or in advanced discussions. Between 2016 and 2018, management promised $30 billion in cash from divestitures. Proceeds are earmarked to reduce debt. Concerns about Shell being forced to settle for “fire sale” prices, or an inability to close deals fast enough failed to materialize.
As outlined initially by Van Beurden, the 3-year divestment strategy is about simplification, not mortgaging the future or shrinking to pay the dividend.
Concurrent Production Increases
At the end of 2015 (prior to BG), Shell produced 2.95 million BoE/d. Given more than half the divestitures complete, 2Q 2017 total production climbed to 3.62 million BoE/d. In other words, while operating expenses declined by 20%, energy production increased 23%.
In addition, long-lead, major capital projects are coming online. These projects are scheduled to deliver $5 billion incremental cash flow this year. By 2018, Shell management expects $10 billion incremental cash flow from these projects.
Capital Returns and Debt Reduction Are In Focus
CEO Van Beurden anticipates near-term Return-on-Average-Capital-Employed (RoACE) to reach 10%; far eclipsing the ~7% returns the company’s experienced during the 2012 to 2014 boom cycle. The mark is now 4%; up from negative returns in 2016. As the major capital projects come online, “dead” capital comes to life and RoACE will rise.
Net debt and gearing are on the way down. Gearing is 25.3% now, on its ways towards a 20% target.
Cash Flow and the Dividend
Most importantly to income investors, the trailing 4 quarters’ operating cash flow covered the dividend easily. Over these quarters, Shell generated $38.45 billion operating cash flow. Capital expenditures were $22.10 billion. Dividend payments totaled $10.58 billion.
The arithmetic and the chart is compelling.
Indeed, Shell is NOT borrowing to pay the dividend. Notably, the ongoing script program continues to dilute current stockholders; however, the past year has seen the total number of shares outstanding rise by only 2.3%. On the 2Q 2017 conference call, management is well-aware of the script program’s dilutive effect, and desires to end it as quickly as possible. Nonetheless, corporate financial priorities remain unchanged:
- Reduce debt
- Fund the dividend
- Reinvest for growth initiatives
Shell CFO Jessica Uhl reinforced management’s view of the script program during the 2Q 2017 conference call:
And I do want it to be very clear, our commitment to taking the scrip off as soon as it’s appropriate to do so. So, the – if I’ve used different language, I would not want that to leave any other impression than that one. It is about getting our gearing down to 20%, getting our debt to the right levels and taking the scrip off as soon as possible. We’re absolutely committed to doing that.
Again, we’re focusing on the fundamentals of the company and driving our cash flow to a different level, driving our profitability to a different level. This will make us a healthier company, a resilient company that ultimately can pay our dividends by cash year in year out and that’s really what we’re driving our company to be and again to get the scrip off as soon as we possibly can.
All This While Prices Realized Plummeted
In order to appreciate the magnitude of these achievements, here’s a table summary of Shell’s 2012 to 2017 prices realized:
Crude oil prices have been slashed in half. Gas is down my more than 40 percent. Shell managed to completely integrate and absorb another major corporation, grind down costs, increase total production, and generate nearly as much cash flow as it did in 2013.
I find the picture pretty clear, don’t you?
Looking Forward
Under CEO Ben van Beurden and his staff, Royal Dutch Shell is positioned to manage itself in a sub-$50/bbl oil world. Shell does not need $60 or $70 oil to sustain positive net cash flow.
Tight controls on opex and capex are not about to slip under the current regime. Heading into 2018, a bevy of high-profile, cash-rich projects are poised to generate incremental cash flow. Shell is running for cash, capital returns, and intent upon making a long-term, sustainable investment case for its stockholders.
I maintain the dividend is secure. I’ve stated this position previously; and continue to do so. Shell has not cut its dividend since 1945. It is highly unlikely to happen now: not on Ben van Beurden’s watch.
I contend RDS shares are arguably the best deal in the oil patch: a sound and improving balance sheet, an indisputably outstanding franchise, the company is very well-managed, generates enormous cash flow, and is exceedingly shareholder-friendly.
Additional disclosure: very long RDS.A
Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2017 investments.
Disclosure: I am/we are long RDS.A.
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.
