It is historically unusual for Royal Dutch Shell to yield over 6%. This is a company with a very long history of having a fair value that also corresponds to a dividend yield between 5% and 6%. Given how well the American stock market has performed over the past six years, it can be wise to take a look at any large company that appears to be offering a discount.
Royal Dutch Shell does $360 billion in sales per year. Hershey, which I covered yesterday, is worth $15 billion in its entirety. To get a feel for how large Royal Dutch Shell is, you could convert the amount of crude oil and natural gas that Royal Dutch Shell sells annually to the ability to buy the entire Hershey business 24x over. It is, without a doubt, massive.
Now, when people talk about being value investors, they often express a desire to purchase a company working through some kind of distress that causes it to become unpopular and offer a discount. It is very easy to advocate this in theory, but more difficult to execute in practice.
With WTI Crude Oil currently at $57 per barrel, many oil companies are reporting lower profits that have also dragged their profits down. What I like about Royal Dutch Shell is that the company is still going to make $13 billion per year even with lower oil prices. That’s down quite a bit from the all-time high of $31 billion in profits back in 2008 when the price of oil was peaking at $145 per barrel. But it still one of the twenty most profitable companies in the entire world, despite the comedown in oil prices.
My attraction for energy companies was borne out of Jeremy Siegel’s research: Companies like Exxon and Chevron, which had much lower earnings per share growth rates over the long haul than spicier offerings like IBM, nevertheless delivered better long-term returns because the dividend yields tend to be higher and the extended years of cheap valuations gives you that special something extra if you chose to reinvest.
My attraction for Royal Dutch Shell emerged as a result of studying Royal Dutch Shell’s ability to deliver 14% annual returns over the course of the 20th century despite having an earnings per share growth that was only a bit over half that amount, and cutting the dividend six times over the course of the century. Investors have always been concerned about Royal Dutch Shell’s ability to grow the business, and all the years of high dividend payments never quite got their due respect. Even through some of the dividend cuts along the way, the point remained: Royal Dutch Shell gives you a lot of income compared to the amount of money that you have to put out.
To continue my recent trend of criticizing the S&P 500’s methodology for stock selection, I have add that it has been foolish to remove Royal Dutch Shell from the index in 2002. The reason why the S&P 500 kicked out Shell had nothing to do with the operating results. They didn’t like having an Anglo-Dutch company featured so predominantly in the index, even though almost 30% of Royal Dutch Shell’s stockholders are American. This has cost the index 0.2% in annual returns as S&P 500 Index investors have missed out on the fat dividend payouts from Shell during the rise in energy prices during most of the 2000s.
Part of the reason why Shell has gotten cheap is that the spread between Shell’s dividend payouts and annual profits has gotten quite narrow. It makes $13.0 billion in annual profits based on current oil prices in the high $50s, and pays out $11.8 billion in dividends per year. That dividend should be safe unless oil falls another 10% or so and stays there for two or three years. Of course, I wouldn’t expect much dividend growth over the next five years, as it may take a bit of time for profits to grow and Shell will probably want to get its dividend payout ratio down to a more manageable level before hiking the payout again.
But still, a dividend under threat and lower oil prices are the ripe conditions for getting value. When Shell was making $31 billion in profits back in 2008, the price of the stock was $87. You got to collect a lot of the dividends in the six years since then so the difference between $87 and the current price of $60 isn’t as bad as you think. But still, it’s clear that you want to arrive on the scene when the profits are lower rather than when they are high.
If Shell maintains the dividend for the next 10 years, the $3.76 annual payout will give you $37.60 per share in income for every $60 share that you buy. Given that I’d expect an annual dividend growth rate of around 3.5% or so annualized when you size up the 2015-2025 period in total, I think these dividend estimates are slightly on the conservative side.
To me, this stock is especially attractive if you are considering an investment within a retirement account. The idea that someone with 500 shares of Shell could pick up $18,800 in total dividend income over the next ten years to invest into other things that would, in turn, pay dividends of their own sounds like a nice engine to start the virtuous cycle of passive wealth building.
I also like the fact that the commodity cycle is different from the rest of the economy as a whole. Yes, in 2008 and 2009, oil fell along with just about everything else. Sometimes, the tentacles of a bad economy can reach all sectors. But there are also times, like right now and 2000-2002, when energy markets enter periods of distress while the rest of the stock market and employment markets are holding up much better.
In 1972, it would have been a great time to buy Exxon and Chevron, but not brilliant timing to buy Coca-Cola, Johnson & Johnson, or Pfizer. And oil stocks were performing much better in 2010 and 2011 while healthcare stocks were getting cheaper due to the uncertainty of Obamacare and the defense sector stocks got cheap due to the threat of sequestration. It has decent potential to serve as a non-correlated asset class because new financial regulations or new healthcare laws aren’t going to affect an oil company’s decision to drill.
The appeal of owning something like Royal Dutch Shell in an IRA is that it lets you get around the annual contribution requirements. Because tax-deferred accounts are a sweet deal compared to plain vanilla taxable account investing, you are going to face annual limits. The specific amount will vary based on whether you are talking about a Roth IRA or a 401(k), and whether you are at an age that permits those extra catch-up contributions. But the premise remains that there is a limit. One of the ways to offset this is by stuffing those accounts with companies that do excellent jobs of generating cash and returning a big chunk of that cash to shareholders.
If it took you a bunch of years of diligent saving to get your hands on 500 shares of Royal Dutch Shell, you can take the annual cash payment of $1,880 and mix it with your $5,500 Roth IRA investment you’re your $1,500 monthly 401(K) contribution. It puts some icing on top of the other fresh investments that you are about to make. I don’t know where the price of the stock will be in the near term, nor do I have complete confidence in the dividend payment in a worst case scenario that saw oil at $40s for a few years, but I know that buying beaten-down giants that make $13 billion in annual profits while they are down tends to work out well for patient shareholders even if there are a few foreseeable bumps along the way.
Originally posted 2015-05-28 13:05:47.