Big Oil Dividends

I am intrigued by the risk management technique of dividend extraction–buying high yielders with slow dividend growth or medium yielders with medium dividend growth–in which you receive a large percentage of your purchase price back in the form of dividends as a reward for sticking around for awhile.

I have made no secret of the fact that I think quite highly of Royal Dutch Shell, despite the fact that it is frequently maligned in the popular media. I think it is because Wall Street will never truly get behind supporting something with a middling growth rate. People are attuned to desire growth, growth, growth.

If you’re well off, and you ever find yourself buying thousands and thousands of shares of Royal Dutch Shell, you really need to get your hands on the four-volume set “The History of Royal Dutch Shell” by Stephen Howarth, Joost Jonker, Keetie Sluyterman, and Jan Luiten van Zanden. The lead author, Howarth, is probably the most knowledgeable man about Shell’s history alive today, if his five books and 10,000+ pages on the culture, people, and machinery of the company can be used as dispositive proof. A new copy of the set will set you back more than $300, though used copies can be purchased cheaper.

From 1907 through 2007, Shell returned over 14% annually for people that reinvested. The earnings growth rate of the firm was only 7%. The rest came from the dividend, and the added effect of reinvesting when the price of the stock was undervalued. It’s one of the most neglected areas of the stock–an investment of $1,000 in 1907 would have grown to $1.1 billion today before you take into account taxes which would reduce your total to the $700 million range.

And it’s not like Shell was a small fry back in the day–it was deliberately engineered as an offset to John David Rockefeller’s growing influence in Europe and no less than Adolf Hitler begged the Shell management team to supply the gas for German tankers. During the flailing Operation Barbarossa, Hitler convinced Benito Mussolini to nationalize the Shell subsidiary Nafta Italiana to facilitate the seizure of Moscow. Stalin was able to block this, but it gives you an idea of the vastness of Shell’s resources in that it played an enormous role in the continent’s battle over resources.

Dr. Jeremy Siegel’s research on the topic also confirms that Shell’s success was not limited to the early 20th century. By 1956, it was trading places with the legacy Standard Oil company Exxon for largest firm in the world. And still, from 1956 through 2003, it managed to deliver nearly 13% annual returns. High dividends, undervaluation, and moderate growth. The same formula, repeated for a century.

Once again, Royal Dutch Shell finds itself in one of those positions where it may very well deliver 12% to 13% annual returns for the investor that buys some of the stock today. The $52 per share price of the stock makes it one of the most irrationally valued large-caps in the world if you are looking out 20+ years. It’s going to make $14.5 billion in profit this year. That is enormous, and is wildly impressive when you consider that this fact fully reflects the full declines in the price of oil. This $3.76 dividend is still only 83% of profits.

And Royal Dutch has tapped the credit markets to prepare for an extended period of low oil prices (fortunately for shareholders, interest rates are incredibly low.) In early 2014, before this oil slide started, Shell had $35 billion in debt and $9 billion in cash on hand. Now, Shell has $53 billion in debt and $27 billion in cash on hand. Some of this will go towards paying the dividend, some towards the BG Group acquisition, and some towards a desire to have more liquidity during the downturn of the cycle. It is superior to BHP Billiton and Kinder Morgan in that its debt load is more manageable and the dividend is still being covered by current cash profits (although the latter two stand to offer higher immediate capital gains during a spike in energy pricing.)

This 7% dividend yield in unreal. It’s rare to see a yield that high which is still being covered by a company’s current profits. You are being paid a heck of a lot to absorb the volatility in the stock price. Factor in 5% long-term earnings growth, and a bit of extra from the reinvestment of dividends at low prices, and you could be looking at 13% long-term returns again. This is a phenomenon potential awaiting an already behemoth company that generates nearly half a trillion dollars in annual revenue.

Imagine if you modeled only a penny per share in dividend growth over the next ten years: You’d collect $3.80 in 2016, $3.84 in 2017, $3.88 in 2018, $3.92 in 2019, $3.96 in 2020, $4 in 2021, $4.04 in 2022, $4.08 in 2023, $4.12 in 2024, and $4.16 in 2025. That would give you $39.80 in total dividends over the next ten years, and that is a low end estimate of the total dividends that shareholders will receive. But still, my low end of reasonable estimates indicate that Shell shareholders will collect $76.53 in cash over the next ten years for every $100 that they put into the stock at today’s valuation.

I am surprised at how often people both: (1) underestimate the value of high-yielding stocks that are able to grow moderately over the long haul, and (2) run away immediately when the price of the stock falls. People look back at firms like Wells Fargo, American Express, Aflac, General Electric, and U.S. Bancorp during the financial crisis and wish that they could have positioned themselves well for rapid dividend growth and strong returns in the years ahead. Well, in order to receive those superior returns, you had to set aside recency bias, absorb volatility in net worth, and think in terms of an entire business cycle (recognizing how lucrative margin of safety mixed with dividend reinvestment can truly be.)

Royal Dutch Shell gives you an opportunity to build that kind of income. Heck, someone that buys 100 shares of Shell today and clicks the reinvest button will be owning around 107 shares of Shell this time next year. Even immediately, the ball gets rolling. Queen Elizabeth and Queen Beatrix own enormous blocks of millions of shares of Royal Dutch Shell stock. It pays for palace upkeep and living expenses. It really is an opportunity for the small investor to buy her/his own oil well, and it really is one of those things that starts putting a lot of cash in your bank account on a regular basis compared to the relatively small amount of initial capital that you have to contribute initially.