Royal Dutch Shell: From One Correction To The Next

My goal for as long as I can keep it up: Refrain from using the word crash to describe typical fluctuations in the energy market. During one particularly brutal period of John Rockefeller’s capital planning life, he saw the price of oil fluctuate between $0.10 and $10.00. Ten cents! Ten dollars! That adds some perspective to the current–correction?–in the price of oil that has seen the commodity go from $100+ barrel in the past few years to the $40s today.

But a study of the oil markets will give you a newfound appreciation for Benjamin Graham’s margin of safety–getting a good entry price really does protect your from darn everything. Imagine if, in 2008 and 2009, you saw Royal Dutch Shell price’s decline into the $30s as the price of oil got cheap and the backdrop of an economic crisis made the stock cheaper than long-term projection of oil fundamentals warrant.

Today, there may not be the backdrop of economic crisis that we had six years ago, but the fundamentals (in the short term) for oil have been impaired much more than was the case in 2008-2009.

But look at what happened to investor that has held onto the stock for six years: You collected $3.36 in each year from 2009 through 2011, got $3.42 in 2012, received $3.56 in 2013, collected $3.72 last year, and should collect $3.76 this year. You got to collect $24.54 in cash dividends from Royal Dutch Shell over the past six years, assuming no dividend reinvestment. That is almost half of the current share price.

The headlines talking about the horrors in the oil markets misstate the experience of the medium-term investor, especially if you got the stock at a decent price. If you count the effect of dividends, someone that purchased the stock at $40 during the last slide would be up to: $50 in share price + $24.54 in cash dividends= $74.54 total. The oil commodity has declined almost 50% in price, and the stock price has followed suit, and yet you are still almost doubled your money.

Somewhat paradoxically, this is one of the rare measurement periods where reinvesting dividends would result in lower net wealth than collecting them in cash outright. This anomaly will disappear at some point, but right now, it exists because the average Shell dividend got reinvested at $56 per share while the price of the stock trades at $50.

But still, a 100 share investment in 2009 would result in 145 Royal Dutch Shell shares today. For those of you that like to make initial investments, and then see the annual passive income rise to the sky, Royal Dutch Shell has been a near perfect income stock. Those 145 shares would be paying out $545 in dividends. On a $4,000 investment in 2009. So every dollar you invested into the largest oil company in the world (by revenues) would be collecting $0.136 in annual income.

For someone eyeing retirement, it could turn into an important leg stool of a retirement program: $100,000 invested into Shell six years ago would be paying out $13,600 in annual income per year. Even if you are not retired, that gives you a lot of incoming cash to reinvest, invest into something else, or help pay for life.

The reason why I like the company so much is that it is still immensely profitable, even with oil in the $40s. All the disparaging headlines about this, and some of the other oil giants, only point out relative changes in profitability or the strain between the dividend payout and annual profit. Very few have pointed out how absurdly profitable these oil giants still are–Royal Dutch Shell is on pace to make $14.5 billion in profits this year.

To emphasize the point: Coca-Cola, which makes $8.8 billion across over 200 countries, makes less than Royal Dutch Shell after a 50% drop in the price of oil. A respect for that $14.5 billion in annual profits, even while oil remains in the $40s, is why I would feel confident treating it as a hell-or-highwater holding even if oil traded in the $40 range for a few years and the dividend had to temporarily be cut.

That said, I don’t think the dividend will be cut anytime soon. Shell has taken some steps to shore up safety, bringing back the Scrip Programme to pay shareholders their dividends in the form of stock instead of cash outlays. It’s a classic example of a low cost of capital move–the shareholders get diluted just a bit from 3.25 billion to 3.255 billion as a result of this decision, but Royal Dutch Shell keeps to keep cash on its hand to ride out the storm.

It also sold some assets in the $70 range and tapped its credit facilities, as the company now carries $26 billion in cash (when oil prices were over $100 per barrel, Shell carried $9 billion in cash). I imagine that money will be used to pay the dividend and acquire upstream producers that are flirting with bankruptcy.

Incidentally, this is why the integrated oil model works, and why I suspect Conoco might be regretting its decision to spin off its midstream and downstream (refinery) divisions in the form of Phillips 66 back in 2012. It is the high refining profits, and chemical profits, when oil gets cheap that allows you to keep the dividends coming in and then go on the offensive to purchase upstream companies outright that are unable to take on additional debt to survive. It’s the most predictable form of corporate darwinism in the economy–it happened in 1986, 1999, 2009, and it will happen again now.

Monarchies have been built, and maintained, on the backs of Royal Dutch Shell shares. Queen Elizabeth receives more dividend income per year than the sum of all her personal and philanthropic annual initiatives, and Queen Beatrix from the Dutch House of Orange has been one of the few monarchs to enlarge her economic might in the past quarter-century because of her unusually large position in Shell stock.

These royals know what the headlines miss: This stock pumps out a lot of cash, and when you tally the cumulative dividends, it is an impressive holding even when you measure it during a 50% commodity price drop. There aren’t many companies that can see their profits cut in half, the share price follow suit, and you still end up nearly doubling your money over the previous six years. But it is exactly what happens when you mix a value investing price with high dividends from a battle-tested company. The long-term history of Royal Dutch Shell is off the charts–with nearly 14% annual returns over the course of the 20th century–but the medium term for the company isn’t too shabby either if you buy the stock during a steep correction in the energy sector.