Royal Dutch Shell Review – A Company in Transition.

INTRODUCTION

Royal Dutch Shell has an impressive history which can be traced back as far as 1833. However, the Royal Dutch Group as we know it today was born in 1907 when two Rival companies from the UK and the Netherlands amalgamated.

RDS.A is one of the world’s largest and most recognizable integrated oil companies. When you see the Shell symbol, you would be forgiven if your first thought was oil. However, what surprised me is that they are very much an integrated Gas company.

Just to give you an idea of scale, Shell has 83,000 employees in more than 70 countries.

Shell Operates within 3 main operating segments

1. Integrated Gas and New Energies
2. Upstream
3. Downstream

Management

Van Beurden joined Shell in 1983 is very much a one-company man since graduating from Delft University of Technology in the Netherlands as a Chemical Engineer. Ben was Downstream Director from January to September 2013. Before that, he was Executive Vice President Chemicals from 2006 to 2012.

In this period, he also served on the boards of a number of leading industry associations, including the International Council of Chemicals Associations and the European Chemical Industry Council. Prior to this, he held a number of operational and commercial roles in both Upstream and Downstream, including Vice President Manufacturing Excellence

ben is praised for his knowledge of the industry and proven executive experience across a range of Shell businesses. Van Beurden is credited with turning around Shell’s struggling chemicals division. From a loss-making enterprise in 2008, the Chemicals business now contributes 5 percent of net earnings.

Business Analysis

Oil and gas are an extremely volatile market which is affected by a number of factors outside the control of the company. Geopolitical conflict, supply concerns, and even the speed of global economic growth can affect the price of Shell.

Even in the face of all these concerns, Shell had managed to not cut their dividend since after the world war until recently. More on that later.

Integrated gas

The bulk of their earnings comes from integrated gas. This segment manages LNG (liquefied natural gas) which includes :

1. exploring and extracting natural gas,
2. the operation of upstream and midstream infrastructure that delivers gas and liquids to market.
3. Converting gas into LNG

It also markets and trades natural gas, LNG, electricity and markets and sells LNG as a fuel for heavy-duty vehicles.

Downstream

The Downstream business consists of Oil Products and Chemicals activities. Products sold include gasoline, diesel, heating oil, aviation fuel and they also provide electric-vehicle charging points. Shell also produces and sells petrochemicals for industrial use worldwide which benefits from low oil prices. This helps protect shells’ revenue when the average price of crude oil drops.

Upstream

Shells Upstream business explores for and extracts crude oil, natural gas and natural gas liquids. It also markets and transports oil and gas, and operates the infrastructure necessary to deliver them to market.

Company Growth

Over the last 5 years revenue has increased with a CAGR of 5.41% as you can see from the chart below as revenue increased from $264,964 million to $344,877 million.

However since 2011, revenue has declined from $470,171 million. The biggest drop unsurprisingly coming during the 2015 oil crisis. This is directly impacted by the average Brent oil price ($/bbl) which was $111.26 in 2011 and is now just hovering above $40.

Fisical 2020 Q2 Earnings Results

It was not much of a surprise but Q2 was a pretty dismal Quarter for Shell. they reported adjusted earnings of $638 million compared with net profit of $3.5 billion over the same period a year earlier and $2.9 billion in the first three months of 2020.

There may be still more pain to come as shell forecasts Brent price to be $40 in 2021 and $50 in 2022. Previously they had foretasted over $60 in each of these years. For every $10 difference in the cost of oil, it is estimated to be worth $6 Billion to Shell.

Dividends

In Q1 2020 shell cut the dividend for the first time since World war 2. There has been signs over the last number of years that this was coming but the pandemic and the Saudi price war was too much to handle this year.

Shell reset the quarterly dividend from $0.47 per share to $0.16 per share in order to:
1. Protect and improve the resilience of the company
2. Sustain and grow the value of the company
3. Enable future growth and shareholder distributions

Shell also reiterated an unchanged progressive dividend policy and plan to Grow dividend per share and buy back shares when market conditions allow.

They seemed to have learned lessons from 2015, given the uncertainty the dividend was not sustainable and it appears to be a good choice to cut it when they did. At the current price of just under $30, you will still get a dividend yield of 4.38%

Payout Ratio

The Payout Ratio is a good indicator of the sustainability of dividends. I have discussed the different methods for calculating the Payout Ratio here.

As we have seen with revenue and earnings the payout ratio is also quite erratic based on oil prices. I think it is worth noting that when oil prices are relatively high, management was always prudent not to overextend the company. They currently hold a AA- Credit rating which helps them borrow at low costs to help cover dividends in lean times.

Would I buy this company?

Please see my disclaimer before reading on. These are my thoughts and are not to be used as investment advice. I am simply outlining my thought process when deciding if I should buy a company or not. Please do your own due diligence and check all data for your self.

This will be broken into 6 different sections with the maximum points per section are outlined below.

Section	Max Points
Financial Strength & Future Proof	25
Management Quality	15
Dividend Quality	20
Valuation	20
Story of the Stock	15
Momentum (TA)	5
Total	100

A recommendation is than provided based on the over all score out of 100.

European DGI was kind enough to share this model with me and he also has a spreadsheet made that you can find here!

Financial Strength and Future Proof

Shell scored a respectable 16 out of 25 in this section. At the end of 2019, Shell had a D/E ratio of 0.43, this is better than the industry average of 0.71. Interest coverage is over 5:1 (FCF/Intrest on debt) which is far greater than the 3:1 ratio that I look for.

Cash flow has been stable over the last 10 years while the dividends are covered depending on the price of oil. In the next two years, the estimated price of oil is estimated in the $40 to 50$ range which is similar to 2016 and 2017. In both of these years, earnings did not cover dividends and in 2016 FCF also did not cover dividends. This time however Shell has cut the dividend which I believe was a good move and will allow them to continue paying this dividend going forward.

The only negatives I had in this category is that the earnings per share growth have declined over the last 10 years.

High Dividend Quality

Shell scored 10 points out of a possible 20 in this section which is not surprising due to their dividend cut and also slow growth rate. Their current yield is 254% greater than the SP500 and I expect the dividend to be safe over the next few years in light of the dividend cut.

Valuation

PE ratio

The PE ratio is not a good indicator for oil and gas companies. Because oil prices fluctuate it makes earnings volatile make this a difficult indicator for this sector.

DDM

The dividend discount model that I use is not a good tool at this moment for shell as they are currently not growing their dividend. Making a guess that the dividend will not grow for 10 years and will then grow 2.28% after this time gave me a valuation of $14.38. However I take this with a grain of salt.

With my usual valuation techniques rendered useless, I relied on outside help to try and help value Shell. Finbox gives a fair value of 237$ which gives a 764% Upside from current prices while simply wall st gives a fair value of $99 dollars.

This section scored 18 out of 20

Story of the Stock

In this section, I look at the market place in general, is it stable, can the company continue to grow? Do they Innovate and how efficient is there organisation. I also look at the overall share count, Are they reducing this over the last 5 years?

As we have mentioned many times in this article, the market place is not stable but one message that comes apparent from Shell’s Investor relation Quarterly results presentations is that Shell want to be on the forefront in terms of energy transition to zero emissions energy.

In fact the CEO Van Buerden has stated that shell should no longer be seen as an oil company.

The very fact that, in this interview, you referred to us as an oil company is symptomatic of the problems that we are facing,” he told Bloomberg Green.

The strategy is ambitious. The goal is to cut all emissions to net zero by 2050. Every internal combustion engine, every power plant, every petrochemical factory—all downstream fossil fuel consumers will one day be required to capture their emissions, or plant forests in compensation.

Acquisitions

Shell is also heavily betting on rapid growth in the global LNG market with the acquisitions of British Gas group in 2015 and Harira LNG in 2019. This has helped shell become the biggest independent natural gas producer in the world.Shell still very much believe in this sector and expect it to grow at a rate close to 4% a year.

Shell also risk alienating investors with the recent drastic cut in dividends. It is natural that dividend investors will see shell as a less valuable company at the moment, who are still feeling the effects of debt from the acquisition of British gas.

Expected returns?

The question on my lips as an investor is should I expect lower returns in the green transition? Cutting the dividend is one clue that maybe the company do expect the return to be lower in the future.

I am also a little concerned at how they will be able to fund this transition if oil price remain at suppressed levels. If the oil prices were to remain low in the new global landscape post covid 19, than you would imagine that the company would have to assess there current countermeasures and this may mean cutting the dividend altogether.

In saying that the board are very bullish on the possible returns on renewable and expects to make between 8 and 12% in the power sector. This will come from wind and solar energy. This seems very ambitious to me but I am impressed with shells willingness to innovate and change the landscape of the company over the next couple of decades.

This energy transition requires a different type of investment and a different type of company. It’s not going to happen if there are no returns to be made.

Check out Van Beurden interview with bloomberg green here

Shell scored 9/15 in this section, even though the market is volatile and they face some serious tailwinds over the next couple of years. The energy transition is positive in my book but I am not expecting quite the same returns as the shell board. My theory is that the dividend was cut in line with these new expectations and from this standpoint, I don’t see them cutting the dividend again anytime soon.

Tech Analysis

I call it tech analysis, but really I just check to see if there is a selling climax happening and if the stock if overbought of oversold. In this case, the RSI is just above 32 which is close to the oversold area. I also used the CCI indicator after a great tutorial by Russ over at Dapper dividends and it is getting close to the buy area.

Overall this section scored 5/5

Recommendation

My Scoring recommendations are as follows

Recommendation	Score
Strong Buy	90 – 100
Buy	70 – 90
Hold	50 – 70
Sell	30 – 50
Strong Sell	0 – 30

With a current score of 70, Shell gets a BUY recommendation from me. Note this is not investment advice and as a disclaimer, I am Long $RDS.A. I will be adding to my position over the next couple of weeks.

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