By Mark Bern, CPA CFA
Royal Dutch Shell (NYSE:RDS.A) is one of the world’s largest integrated oil companies. With a yield of 4.8%, I like the dividend. I also like the future prospects in the 3-5 year range and beyond, but I don’t expect much appreciation in 2012. I’ll try to lay out in simple language what I like and dislike and why.
What I like
Not so long ago, this behemoth set out to reinvigorate itself with an ambitious plan to increase the utility of its more unconventional assets by applying new drilling technologies. Over the next few years we will begin to see some of the fruits of that plan, including two processing plants in Qatar, one to turn gas into liquids and the other to ship liquefied natural gas liquids. The company has a venture with huge deposits in the oil sands in western Canada that should begin to produce that could raise overall oil and gas production by 5-10% when it hits stride. Shell has a large shale gas position in North America that should add to the bottom line once gas prices firm. Deep water drilling the Gulf of Mexico holds considerable promise for Shell. The company is also building a floating LNG plant off Australia.
Long term, the demand for gas and oil will surely put upward pressure on prices. All in the sector will win big and Shell is positioning itself to take full advantage. The dividend provides a healthy yield while the payout ratio remains a very manageable 40%. The company is divesting non-core assets and reducing exposure gradually in the refining business while using the proceeds to invest in exploration and production. Shell has a strong balance sheet with over $19 billion in cash on the books as of the end of September and long-term debt equals only 16% of capital. Interest coverage is about 25 times and the dividend looks very secure.
What I Don’t Like
Qatar is a relatively stable country in a very unstable region. The gas processing plants are probably safe, but disruptions in that part of the world are always possible. Gas prices are likely to remain depressed for another year or more, in my opinion, until demand for gas improves in such areas as electric utility transitions from coal. The lead time required to bring deep water fields into production is long and will probably serve mainly to offset production losses in other fields by the time the new fields come on line. Revenue growth will probably be minimal for a couple more years at least as divestitures of non-core assets take bites out of the revenue as new revenue streams are added, muting the effects of improvements made for a few more years. I expect dividends to rise by less than 4% a year over the next few years as the company continues to reinvest in the future.
My Overall Opinion
I like the company for patient investors with a time horizon of at least three to five years. The dividend yield of 4.8% provides nice current income and covered calls can be sold against holdings to enhance the income while one waits for the appreciation. On the other hand, I suspect this stock may present a better total return potential if the investor were to hold off on a purchase until late 2012 or maybe even sometime in 2013 as the growth in newer revenue streams begin to add more to the top and bottom lines and oil prices firm up as the global economic growth picture improves.
As always, please take the time to do some research before investing in this or any other investment you run across. Use the information provided in this and other articles as a starting point in your investment decision-making process.
If readers are interested in other oil company articles I have written, for ConocoPhillps (NYSE:COP) and Exxon Mobil (NYSE:XOM), the links can be found here (for COP) and here (for XOM). I intend to add a few other oil company articles in the near future, as well.
Disclosure: I am long COP.