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Royal Dutch Shell: cash flows coming

Dividends are no longer a source of near-term concern for the super-major's investors
Royal Dutch Shell: cash flows coming

Policy: “To grow the US dollar dividend in line with our view of the underlying earnings and cash flow of Shell.”

Forward yield: 5.3 per cent

Payment: Quarterly, declared in dollars, paid in sterling (class ‘B’ shares)

Last cut: 1945 (as Royal Dutch)

IC TIP: Buy

“A wall of free cash flow is coming.” That line, from a recent HSBC research note on the oil and gas sector, is probably more true of Royal Dutch Shell (RDSB) than any other supermajor. For most of the past three years (regardless of the historic cyclicality of resource markets), such a statement would have been inconceivable. But now, with its income-generating credentials no longer under question, the largest single contributor to UK investor dividends is faced with a rather luxurious conundrum: what to do with all that cash?

We have a relatively good idea of the answer. With its cost structure reset, and after two years of meeting its promises to investors, Shell’s strategy appears to place shareholder returns ahead of chasing market share. In 2018, after operating cash flows, the group expects capital expenditure to come in at the lower end of a medium-term annual target range of $25bn-$30bn (£19bn-£23bn).

That, according to analysts, should leave behind $20bn-$22bn in ‘organic’ free cash flow (that is, cash before any disposal proceeds) each year until 2021. Add to that annual divestments of around $5bn, and Shell now looks to have excellent cover for dividend payments. With the dilutive scrip component abandoned, these will suck up $16bn in cash every 12 months.

This marks a break from Shell’s income case between 2015 and 2017, when disposals were required to fund the payout and prop up a balance sheet already strained by the acquisition of gas giant BG. That purchase proved timely, although the company’s inclination to return to the deal-making table – tempting given depressed price-to-cash-flow valuations across the sector – could be checked by management’s desire to reduce borrowings to 20 per cent of equity.

After that point, Shell has signalled that share buybacks are preferable to a sudden expansion in production and projects. On that score, the Anglo-Dutch group wants to retire some $25bn of shares by the end of 2020, a task analysts at HSBC reckon is only conceivable with Brent crude at or above $80. But depending on the ability of US shale producers to gobble up market share abandoned or lost by various members of the ‘Opec-plus’ group, such prices are hardly inconceivable.

Whether it reaches the $25bn target – which would juice the nominal cash dividend in the process – a buyback programme makes sense for a group whose core business is now in ex-growth mode. Earlier this year, chief executive Ben van Beurden told investors Shell is no longer a fossil fuel firm, but an “energy transition company” (echoes of Lord Browne). However, there’s reason to believe this is more than an exercise in greenwashing, not least because Shell is making steps into the retail gas and power and electric vehicles markets.

At present, these deals are minor footnotes to Shell’s uses of capital, but the next year could conceivably bring a step-up in investments in its new energies division. Until that happens, Shell’s operating margins mean its cash conundrum looks decidedly skewed towards income seekers.