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Shell remains cautious, even as returns return

The oil major cut its distributions amid unprecedented economic disruption, but remains a cash cow when prices are going its way
Shell remains cautious, even as returns return

On 30 April 2020, Royal Dutch Shell (RDSB) sent a shudder through the financial world, when it cut its dividend pay-rate for the first time in decades. Some pundits had previously cast doubt on the ability of the oil major to maintain its distributions, then worth 47¢ a quarter. And maybe the writing was on the wall anyway, especially after it stopped share buybacks a month earlier, two-thirds of the way through the $25bn (£18bn) programme.

One of the key characteristics of the oil majors is their ability to throw off cash when underlying energy prices are moving in their favour. Naturally, the reverse dynamic also applies due to their capital-intensive nature. But Shell had regularly taken the crown as the corporate world’s biggest dividend payer, seemingly regardless of price swings. That’s because it was usually prepared to effectively borrow money to fund distributions.

But Shell, like other resource groups, is not immune to externalities. March 2020 also featured an oil spat between Saudi Arabia and Russia over proposed oil-production cuts. Prices were already under pressure in response to slowing demand, combined with swollen global inventories. Consequently, Brent crude cratered through March, and the WTI benchmark briefly entered negative territory in late April. In the intervening period, we also witnessed a global stock market crash and the small matter of the pandemic to take on board.

Little wonder then that bosses at Shell opted for discretion, cutting the Q1 2020 pay rate to 16¢ a share, even though the group had recently revealed that available liquidity would rise by nearly a third to more than $40bn.

Where are we now? The Anglo-Dutch group reported adjusted earnings of $5.5bn in the second quarter of 2021, against $3.2bn in the first. The dividend rose to 24¢ in the second quarter and bosses announced the launch of a $2bn share buyback program which it aims to complete by the end of the year. These measures could never be described as baby steps, but caution still predominates.

More to the point, free cashflow had totalled $7.7bn and $9.67bn respectively over the first two quarters of 2021, and the group felt able to retire its net debt target of $65bn – a precursor to the recommencement of buybacks. In the year prior to the pandemic, Shell had forked out $25.9bn to cover dividends and shares buybacks, just shy of the $26.4bn in free cashflow for 2019.

Assuming cash generation remains healthy through the remainder of 2021, there is every chance that distributions will continue to climb, particularly given that the group has taken decisive measures (including 10,000 layoffs) to reduce costs. Reports also suggest Shell could net $10bn through the sale of its Permian Basin interests.

Chief executive Ben van Beurden recently said he has no plans to change strategy, despite a landmark court ruling in the Netherlands which stated that the group’s existing climate targets were insufficiently ambitious and need to be brought into line with the Paris accords. We can’t be sure whether the ruling will be upheld on appeal, nor how it might be enforced if it is carried.

Litigation aside, the funding of longer-term distributions is dependent on the group’s ability to replace production. Equally, revenue from renewables and related government subsidies will pale alongside Shell’s core energy businesses. And as ever, financial performance is also tied to prices for the group’s underlying commodity range, but with distributions creeping back up, income seekers will find it difficult to ignore a prospective yield of 4 per cent. The shares are up by a quarter in a year, but trade at a 28 per cent discount to their 200-day moving average, despite the brighter outlook for returns.


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