Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) released results this morning in Europe. Both the London and Amsterdam listings are down 4%. RDS is yielding about 7% this morning at current prices in Amsterdam.
Let's get the disclosure bit over with. I was long Shell up until a few months ago. I sold as its share price recovered from the January meltdown. Having analyzed the company several times on SA, I concluded I was not comfortable holding the stock. Of course, if I had continued to hold and sold now, I would have made a much better return at today's prices.
But it's hard to go against your instincts and continue to hold a stock that does not suit you. I sold and I am still happy with the decision having deployed the proceeds into businesses with stable earnings that both easily cover the dividend and have a good tendency to grow YoY. In addition, the majority of my stock picks have excellent Free Cashflows to the price paid and decent ROIC. I guess my mentality is just better suited to this type of investing and it's not to say that trusting the long term cycle of the oil market is a poor investment strategy. History would support an oil price recovery investment thesis, but it's not for me.
I am of the opinion that a company I have ownership in should be able to cut its cloth to its measure. Forget the price of Shell and forget the dividend just look at its Statement of Cashflows for H1 2016.
|$ billion||H1 2016||Comment|
|Operating Cashflow||3||Includes 2.3B deferrals of tax and retirement benefits that were due|
|Working capital requirements decreased by a massive 6.3B in the period. More deferral?|
|Operating Cashflow could have been negative without the above cash management|
|JV Investments||0.55||Seems to be ongoing requirement of normal business operations|
|Debt Reduction||2.94||Overall debt on balance sheet is 100B. Is ongoing Annualized Debt Reduction of 6B realistic?|
|Interest Payments||1.26||Seems realistic given interest rates|
|Dividends||4.77||Excludes 2.7B in H1 of Scrip Dividends. Real Dividends figure is 7.5B|
|True Free Cashflow||-17.62||Operating Cashlow less ongoing debt, dividend and capex commitments|
|Disposals||1.42||Assets Sales are going very poorly …. Shell originally guided 10B for 2016|
|New Debt||12.5||Filling Cash Holes with Debt is not sustainable|
|Full Cash Movement||-16.44|
When I see a business that can cover just 15% of its commitments from Operating Cashflows then I don't really care what price the business sells at, particularly when I suspect many tactics are being used to delay cash payments on current liabilities.
What about a long term perspective
So if total commitments for Capex, dividends and debt reduction/management were $20B for H1 2016 then we can say ongoing commitments will be about $40B per year. (I think the $40B is optimistic for the long term given payment deferral, scrip dividends, reduced capex and low debt reduction.)
Looking back to $100 oil in 2014 (the average price of Brent was about $98), we see that RDS and BG had combined OCFs of $52B.
So if oil goes back to $100B then I think Shell works as a business.
If oil goes back to $80, then Shell may work. Operating Cashflows generated will be about $40B which seems to cover the current requirements of the business, its lenders and its investors but not sure $40B is realistic for reasons given above.
My conclusion is to only invest in Shell if you see oil prices going back to minimum $80 on a long term basis.
How long that price recovery will take is also a very important consideration for the investor. Cash management can only go so far and ultimately just kicks the can down the road. Shell's surging debt load to $100B means it has a limited window to wait around for the oil price recovery. Ongoing Cash Dividend payments of $10B per year could well be cut, although Shell has a very fine dividend history so this will not be a decision that is taken lightly.
The BG acquisition was badly timed in hindsight. Other oil majors may provide superior coverage ratios of Operating Cashflows to ongoing Cash Commitments.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.