A Supermajor Bargain in the Oil Patch
04/14/2009 9:00 am EST
Shell's fat dividend and bullish production outlook are selling much too cheaply, writes Peter Shearlock in The IRS Report.
If, like me, you believe that recent weakness in the oil price is merely a temporary blip, the oil majors must look attractive at current levels. Their shares have all taken a hammering as the oil price has come back from more than $140 a barrel last summer to a recent low of around $40. The oil price was last trading at that level in 2004.
Royal Dutch Shell (NYSE: RDS.B, LSE: RDSB.L) looks particularly tempting at the current level. Whereas BP (NYSE: BP, LSE: BP.L) has capped its dividend for the next two years, Shell recently promised to lift its payment to shareholders by 5% this year and is committed to paying "competitive and progressive dividends." At the current 1569 pence for the B shares (which are more widely traded in the UK than the A shares), the 2009 yield is 7.4%.
A rising oil price would be very good for profits. The company's big investment in Canada's Athabasca tar sands is the prime example of that. Shell has said it needs a $38-per-barrel oil price to make money. In the last quarter of 2008, it actually turned in a small loss, compared with a $371-million profit in the third quarter. There is a lot of up side here on a rising oil price.
Without assuming any sustained up tick in the oil price, Shell will see a fall in net income this year from $28.7 billion to under $20 billion. But the projected dividend should still be twice covered out of earnings and Shell has entered the downturn with a very strong balance sheet. Gearing [i.e. leverage, which Shell calculates by dividing its debt by the sum of its debt and equity-ed.] at the end of 2008 was only around 7.5%, or 23% if the obligation to plug a big hole in the group pension fund is counted in.
The company expects its cash position to improve again next year-in part because new production is due to come on stream. Several big oil and gas fields are due to start producing early in the next decade and two huge developments in Qatar-one a gas-to-liquid fuels plant, the other a liquefied natural gas project-are scheduled to complete around the end of 2010. The production graph should be pointing firmly in the right direction by 2011 at the latest.
In the short term, the oil price will determine where the shares go. It is worth noting that the Brent crude futures contract recently moved above its 100-day moving average for first time since last summer. But whether the shares get a boost or not, that massive-and clearly safe-dividend yield takes a lot of beating, come what may.