Why I Added Royal Dutch Shell To My Retirement Portfolio

May 10, 2012 6:16 PM ET3 Comments
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Old Trader is a 63 year old private investor, managing a retirement portfolio constructed to a) generate a high current yield, b) preserve capital, and c) increase capital. His methodology involves taking a "top down" macro view to identify favorable trends, and then engage in fundamental analysis at the company level to identify "best of breed" companies that will benefit from those trends. He employs some simple TA to help determine favorable entry and exit points for positions. The ultimate goal is the construction of an "absolute return" portfolio, fully recognizing that such a portfolio will lag in a strong bull market, but will result in much smoother returns, a characteristic he feels is critical for retirement accounts. Founder and moderator of Chicagoland Investors' Group. Monthly Sunday brunch meetings to discuss markets and investing/trading strategies. I can be reached at sangamon_asset@msn.com

I'm a long time bull on oil, but a few years back, I grew a bit tired of the volatility that comes with the sector. Because my focus is on dividends, my holdings were in Canroys, and I lived through the "Halloween Massacre", when the Canadian government suddenly announced a change in the tax structure that allowed income royalty trusts to flourish, causing an overnight "haircut" of 10-20%. (I took advantage of the situation to add to some positions, fortunately).

Afterward, I decided to move into midstream pipeline MLPs which also provide attractive yields, but with much lower volatility, since their cash flows are relatively immune to the price of the product flowing through the pipeline.

Now, however, the valuations in the MLP sector have risen notably, making me reluctant to add new money there, although I'm still DRIPing my distributions, at least for the time being. Consequently, I started looking at major integrated oil companies to add to my stake in Statoil (STO), which I added because of the firm's expertise in marine/harsh environment production and operations.

Formed by the combination of the Royal Dutch Petroleum Company, a Netherlands-based firm, and the Shell Transport and Trading Company, a UK-based firm, Royal Dutch Shell's headquarters are in The Hague, and the firm's registered office is in London. Shares are primarily listed on the London Stock Exchange (LSE), with secondary listings on the Euronext Amsterdam and NYSE exchanges.

The "B" shares dividends fall under the tax treaty between the US and the UK and are paid in the GBP, while the "A" shares are tied to the Netherlands and are paid in Euros, and lack the advantageous tax treatment afforded the B shares, making the B shares a better holding for investors holding them in an IRA, or other tax-advantaged accounts.

Royal Dutch Shell (RDS.A/B) has come a long way since 2004, when it severely marked down it's reserves by 25%, which knocked the share price for a loop. The firm's also been somewhat "under the radar", in that it hasn't suffered much, if any, of the negative publicity that's accrued to it's competitors, such as BP Plc (BP) and Total (TOT); the Gulf of Mexico spill in the case of BP, and TOT's exposure to events in Libya, as well as a gas leak in its North Sea Elgin field more recently.

Like all of the majors, RDS.A/B is facing increasing difficulties in replacing reserves, but is addressing the challenge on a wide variety of fronts. Increasingly, the firm's focusing on natural gas production, while moving away from oil. Current production favors natural gas over oil by a margin of 57% to 43%.

Although the firm has exposure in the US shale gas fields, by means of the firm's recent acquisition of East Resources (http://www.usatoday.com/money/industries/energy/2010-05-28-shell-buys-east-resources_N.htm) given the state of the natural gas (NG) market in the US, I don't view this as a major plus, given current NG prices in the US. What DOES attract me is the firm's exposure to the Asian markets, and growing involvement with liquified natural gas (LNG), as well as Gas to Liquids (GTL) production. Currently, of the integrated majors, RDS.A/B has the largest LNG operations, with TOT in second place.

Looking at how the firm ranks among it's competitors, RDS.A/B is second in market cap with a cap of $227.8B, behind Exxon Mobil's $396.8B. Interestingly, Royal Dutch Shell is also a close third in terms of yield (4.71% for RDS.B, as of the close on 5-4-12), soundly trouncing XOM's 2.66%.

The highest yielder of the field, which is comprised of Exxon Mobil (XOM), Royal Dutch Shell (RDS.A/B), BP Plc , Total , and Chevron Corp (CVX) is TOT, which yields a nice 5.0%, but is only half the size with a cap of $109.9B.

In terms of yield, the field looks like this:

TOT - 5.0%

COP - 4.87%

RDS.B - 4.80%

BP - 4.57%

CVX - 3.47%

(data taken from Morningstar) www.morningstar.com

I feel that Royal Dutch Shell's size adds a margin of safety when comparing it to other firms that are somewhat cheaper, or pay a somewhat higher yield. In addition, the firm increased its dividend by $.02, from $.84 to $.86, while steadily buying back the B shares during March and April.

The recently announced Q1 numbers seem to have vindicated my choice, with Royal Dutch Shell reporting a 16% increase, from $6.29B to $7.30B, while XOM disappointed with a 11% drop. www.marketwatch.com/story/exxon-mobils-p...

Disclosure: I am long RDS.B, STO.

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