Never Sell Shell Shares (OTCMKTS:RYDAF)
My experience with Shell
I’ve been a loyal Shell (NYSE: SHEL) (OTCPK:RYDAF) shareholder for many years. About two years ago, after the start of the global Corona pandemic, the share price fell by more than half and have reached near single-digit euro prices. I bought a lot at that time and more than doubled my initial position. Now, two years later, I regret not buying more. Meanwhile, the question is whether to take profit and reduce the position or hold the stock.
In many forums you read again and again: Never Sell Shell. I think I’ll stick with that “wisdom” for now, as I believe the company will continue to have great years ahead of it. Meanwhile, I sit back and collect the dividends, which will continue to grow. Share buybacks will also continue to sweeten performance.
Shell is well known as one of the world’s largest vertically integrated energy companies, focused on oil, gas/LNG, power and related chemicals. With the acquisition of BG Group for $52 billion in 2016, Shell secured an excellent market position in the growing LNG segment. However, the company is in a transition phase. This is partly due to pressure from investors and the public to pay more attention to decarbonization.
Shell divested some assets after the Covid-19 outbreak and wants to focus on fewer sites to take advantage of economies of scale even more. In my opinion, this is the right strategy. Ultimately, I could write a lot more about the business model here. However, Shell’s value is primarily determined by current and future oil and gas prices. And in this regard, I am optimistic for various reasons.
Valuation: It all depends on oil and gas prices
In accordance with its economic model, Shell is of course very dependent on the development of oil and gas prices. That is why we must first ask ourselves how Offer and demand will develop.
Oil and gas demand will remain at least stable as long as supply is limited
I see no reason for demand to drop significantly. Growth in Asia in particular is accompanied by an increase in oil and gas consumption. Of course, some parts of China are locked down again due to Covid-19, and it slows down the growth of the economy or the demand for oil a bit, but I think these are temporary effects.
Currently, oil demand is around 100 million barrels per day. More than 40% of it is served by OPEC+, which includes Russia. Russia alone serves around 10% of the market and is the second largest oil exporter in the world. Sanctions and corporate reputation concerns are currently making it difficult for Russia to find buyers for its oil. This means that the world market is missing a considerable part of the supply.
The questions are now:
- Are there any projects that can be used to bridge this supply gap?
- What is OPEC+’s position on sanctions against Russia?
Are there any projects that can be used to bridge this supply gap?
Let’s move on to the first question and look at the long-term impact of the pandemic: With the onset of the Corona pandemic and the rapid drop in oil prices, many projects have been halted or cancelled. I didn’t think prices would go up so fast. But it was clear to me: projects in this sector have a long lead time. In a few years, demand will pick up significantly. However, I doubted there would be a corresponding supply by then.
There is a global trend to rely more and more on renewable energy. This is basically correct but should be done with a sense of proportion. But if banks and investors in some countries are unwilling to provide fossil fuel money, their supply will not improve. In addition, returns from renewable energy investments will continue to decline. This can be seen in a recent example: Orsted, one of the biggest investors in offshore wind, pulled out of a multi-billion dollar auction in February for land leases on the New Jersey and New York because the company was skeptical about the possibility of the projects. generate adequate returns.
What is OPEC+’s position on sanctions against Russia?
The UAE Minister of Energy and Infrastructure insisted that Russia will always be part of OPEC+ and has clear answers to the questions I just posed:
Who can replace Russia today? I can’t think of a country that can in one year, two, three, four or even 10 years replace 10 million barrels. It’s not realistic.
We agree with their target or objective of trying to calm the market and balance the market. But you don’t do it that way. You don’t do that by putting penalties on a hydrocarbon that you can’t replace – unless you want prices to go up.
It is therefore unlikely that OPEC+ will get involved in politics and there do not seem to be any reasonable options to close the supply gap in a reasonable way. In the short term, attempts are made to calm the market by releasing oil reserves, as for example in the USA. However, these measures are not sustainable and eventually wear out. This will likely mean that prices will remain high for the foreseeable future and that there will always be plenty of money to be made from oil and gas.
Because of the conflict between Ukraine and Russia, I see a kind of natural hedge: If the price of oil were to fall sharply, for example due to a drop in demand from China, the willingness of the EU to impose an official embargo on Russian oil could increase. This would again fuel prices.
High free cash flow will allow additional distributions to shareholders
For Shell, high oil prices mean high free cash flow, which will be used as follows:
I believe the distributions to shareholders will be at the upper end of the range indicated in the presentation. This is mainly because Shell’s decision in April 2020 to cut its dividend significantly increased its financial flexibility and therefore reduced its debt. By then, many investors had fled the stock. However, Shell was suffering from significant debt at the time. By early 2021, the company’s goal was to reduce net debt to less than $65 billion. This goal was already achieved much faster last year. At the end of 2021, net debt is just $52.6 billion, the lowest level since the start of 2016.
From a perspective of maximizing shareholder value and optimizing the capital structure, it does not seem to me to be wise to reduce the debt even further. Shell can therefore make additional investments and distribute more to investors.
Let’s take a look at the 2021 numbers: the CFFO was around $55 billion. 20-30% should be paid regularly to shareholders. At the current market cap of $200 billion, that’s roughly a 5.5% to 8.3% return.
However, rising oil and gas prices increasingly materialized in the second half of last year. That means you only see about half the impact in the 2021 numbers.
At an average Brent price of $60/bbl, the CFFO should be around $50bn. According to Shell, a price differential of around $10/bbl creates a CFFO effect of $4 billion for Upstream and $2 billion for the Integrated Gas segment. If we assume an average price of around $85/bbl for the coming year, which I consider rather conservative by the way, the CFFO should be at least $65 billion, probably significantly higher. At $100/bbl, the CFFO is around $75 billion. A payout of 20% to 30% via dividends and redemptions yields a return of 7.5% to 11%. Shell is therefore again attractive for dividend investors.
‘Quick and dirty’ review shows Shell isn’t expensive
For a “quick and dirty” valuation, just look at Shell’s historical P/E ratio and the Forward P/E ratios of other oil companies (according to Cap IQ S&P). The chart shows that Shell was trading at a P/E between 14x and 18x before the pandemic. Currently we are just at 10x for 2021 and even lower for 2022.
Considering the Forward P/E ratio, Shell appears to be cheap even when compared to some peers.
|BP (BP)||TotalEnergies (TTE)||Exxon Mobil (XOM)||Herringbone (CVX)||Saudi Aramco (ARMCO)||Philips 66 (PSX)||Hull (SHEL)|
Given the historical P/E ratio, a doubling of the price would even be possible if oil prices remain high. I think these are good reasons to hold the stocks permanently and maybe even buy some more when the stock price resets.
Disadvantages and advantages
Anything that reduces the demand for oil, and therefore the price of oil, is a risk for Shell. This includes, for example, a sustained global economic downturn. However, mainly due to the catch-up effects of Corona, I don’t see this happening in a timely manner yet. Another risk is, of course, that Russian oil will again find more buyers. However, if an oil embargo or even a gas embargo were indeed to be imposed, Shell stands to benefit enormously. The “quick & dirty” analysis does not take into account that Shell will continue to work on its efficiency. I believe that by focusing on fewer sites, economies of scale can be achieved that will increase returns even at lower prices.
I currently see no reason for oil and gas prices to fall sharply in the foreseeable future. Shell will thus generate high free cash flow and allow shareholders to participate. A return of around 10% per year is still possible at the current valuation. I own the shares and can buy in the event of a setback. In any case, there is currently a lot of money to be made in oil and gas, probably more than in renewables. And certainly more than wind turbine manufacturers earn. Please see my articles on wind turbine manufacturer and industry leader Vestas and its competitor Siemens Energy/Siemens Gamesa if you are interested in “greener” investments.