- Cash flows constrained by lower dividends from joint ventures
- 2022 cash-flow yield in advance of supermajor peers
Most consumers and businesses will be feeling the pinch due to the phenomenal increase in wholesale gas prices this year. However, if any of those consumers hold shares in the world’s principal gas suppliers, they might be able to keep the heating on this winter.
Royal Dutch Shell (RDSB) used to be the world’s greatest source of dividend income, but that came to an end last year when oil prices tanked. A production spat between Saudi Arabia and Russia, exacerbated by an unprecedented slump in industrial demand, sent forward contracts into negative territory at one point. Share buybacks were promptly put on ice and the group’s quarterly distributions were pegged back for the first time in living memory.
All this was doubly troubling given the group’s previous willingness to fund its payouts through debt, but the global reaction to the pandemic put paid to Shell’s largesse. Events have moved on from April 2020 and it could be that the ongoing energy crisis could boost dividends, even as it poses a threat to near-term economic growth.
When we last covered the group in August, we posited that distribution rates could improve through 2021, “assuming cash generation remains healthy”. It subsequently emerged that adjusted earnings and operating cash flow would take a combined $400m (£292m) hit from the impact of Hurricane Ida in the US Gulf of Mexico. Cash flow would also be constrained through the third quarter due to a shortfall of $200m-$300m from the previous quarter as it received lower dividends from joint ventures and associates.
LNG liquefaction outages have provided an operational stumbling block, but the group’s financial performance is generally more reactive to underlying energy prices than its supermajor peers, not a bad thing given their trajectory in 2021. The Anglo-Dutch group is the third-largest producer of natural gas, so analysts will be looking closely at Shell’s free cash-flow prospects over the coming months. Underlying cash flow through the third quarter of 2021 was up 59 per cent year-on-year, but that’s obviously against a rather anaemic comparator.
Naturally, the group’s distribution potential is also bound up with its net debt position. In the year prior to the outbreak, net debt was equivalent to 41 per cent of shareholders’ funds. By midway through 2021, it had fallen to 38.5 per cent, although, importantly, the actual amount had fallen by 16 per cent to $66bn.
Another couple of percentage points are likely to be shaved off that figure once the group’s sale of its Permian business to ConocoPhillips (NYSE: COP) is finalised, although the lion’s share of $9.5bn proceeds have been earmarked for additional shareholder distributions.
Indeed, bosses at Shell had already started the long march back at the 2021 half-year mark, increasing the quarterly dividend to 24¢, in addition to launching a $2bn share buyback programme. The former return remains somewhat short of the 47¢ pay rate prior to the pandemic, but the group is in a better position to restore the dividend than it was at the beginning of the year, although it’s worth remembering that the group’s cash outlay for dividends and buybacks through 2019 amounted to a whopping $25.4bn.
Analysts at HSBC are certainly not ruling out any further increases, as the group seeks to “narrow the yield gap on peers”. The analysts note that although Shell’s prospective yield is still the lowest of the supermajors, its estimated free cash-flow yield is best in class for 2022.
It’s ironic that the energy problems besetting the UK and elsewhere are intensifying in the lead-up to the latest UN Climate Conference (COP26) in Glasgow.
Environmental analysts are touting the conference as the last chance for western economies to firm up their commitments under the Paris accords. So we may get a clearer idea of the extent to which energy companies will need to evolve to meet governmental commitments and the attendant financial implications for shareholders.
The conference comes as doubts intensify over the pace of Europe’s planned green energy transition. There is certainly increased noise over the potential economic damage that the race to ‘net-zero’ could entail. Shell is in the cross-hairs on the environmental front. It is appealing a ruling by a Dutch court that the group must reduce its CO2 emissions by 45 per cent (net) by the end of 2030 compared to its emissions in 2019, but even if the ruling is upheld, the jurisdiction of the court is open to question. More importantly, shareholders need to assess the likely impact of any pledges from COP26 on future cash flows.
