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Shell’s front-loaded returns

While its long-term strategy gradually emerges, the super-major has promised monster returns over the next half-decade
July 11, 2019

Royal Dutch Shell (RDSB) handed investors a pair of binoculars last month, giving them five years worth of dividend and cash-flow forecasts to gaze at. The oil and gas major stuck a big number on its total payouts over that period, too, at $125bn (£99bn). Jefferies estimates this would raise the annual shareholder distribution to 8 per cent, compared with a 9.6 per cent yield in 2019, which includes the cash returns from the current $25bn share buyback programme.

IC TIP: Hold at 2,581p

At a briefing for the 2021-25 forecasts, Shell chief financial officer Jessica Uhl said shareholders could also rely on management to keep handing them more cash while maintaining a steady balance sheet. Once the end of the $25bn share buyback programme is “in sight”, dividend increases are expected, for the first time since 2014. “Dividend per share growth will be complemented with share buybacks to reduce the share count, and over time the amount of the total dividends are expected to reduce,” she added.

This all sounds very promising for the near term, but the super major – and its industry – is in a state of profound change right now. What comes next could put Shell’s run of dividends at risk.

That’s because the company’s upstream oil and gas production has historically provided the group’s highest returns. The business won’t last forever. “The objective of the upstream business now is to generate free cash flow rather than growth,” flagged Jefferies analyst Jason Gammel in a recent note. “Thus, investors may need proof that Shell can increase its return profile as its growth priorities change.” In the short term, the group is also heavily reliant on oil prices. Hydrocarbon markets may need to tighten, too: analysts at RBC reckon Shell needs $70 per barrel to maintain dividends, buybacks and capital expenditure.

There are also other bumps in the road to 2025. Dividends must compete with a management push to rapidly expand Shell’s electricity offering while staying “asset-light” and inventing a new type of power company with far greater returns than the sector currently offers. Mr Gammel is positive on this plan but his bull point about consumers paying premiums for low-carbon electricity supply overlooks the fact those same consumers may not want to do so from an oil company.

 

 

Alongside these moves towards renewables, power and electric vehicle infrastructure, analysts have picked out Shell’s reserves as a weak point. While acquisitions have been floated as a way to boost reserves and future oil and gas production, major corporate activity would have to fit into the $30bn capital expenditure ceiling set out for the next two years.

At face value, the reduction in reserves could shake investor certainty of a long-term dividend at the current levels, but RBC believes Shell has it covered. “The company intends to generate enough free cash flow over 2019-21 to cover its full dividend from just the integrated gas and oil products businesses, both of which are not directly dependent on reserve life,” said analyst Biraj Borkhataria in a note that nonetheless downgraded the stock.