Saturday, 7 February 2015

BUY: Royal Dutch Shell "B"--Energy for the future

Price: 2162.95
Shares: 34
Predicted annual dividend income: £43.74

In case some of you missed it whilst sitting in your en suite cave or lapping up the rays on your isolated private beach, there has been some movements in the oil price recently.

I have been keeping myself at the sidelines through all this to let the dust settle a little. I already have quite a bit of exposure to oil in my portfolio through two purchases in BP made early and late last year.

However, earlier this month I decided it was time to pitch in a little more. In the short term I expect price volatility to still be the name of the (oil) game. However, over the long term I see this as likely to be a wise move. So who did I go for? BP or Shell? Well, on this occasion, Shell.

All under one Shell?

Shell is a corporate behemoth with a market cap of about £140 billion (making it the biggest of the FTSE 100 just ahead of another of my holdings HSBC which again I picked up earlier and later last year).

Of course, like BP it has a number of headwinds facing it in the short term. However, of the two, it generally looks as though Shell has got its act together far better than BP. This is reflected in analysts attitude to both. Shell certainly has the better reputation in their eyes.

Such is the strength (and size) of Shell many analysts have been positing the possibility of Shell making a move for its smaller UK rival. It's not the first time this has been suggested and it is not without its merits. Overall, I don't think this likely due to continued uncertainty over the Deepwater Horizon business. Nonetheless, if it did occur I may well find my entire oil exposure under one shell: Shell. We will see.

However, despite this more positive attitude, greater size and the positive fact that Shell is not sitting in any equivalent "Deepwater Horizon" hot water it seems disproportionately punished by the markets.

This is even more surprising as Shell also benefits over its rival in other ways. It is one of the most geographically diversified oil majors in the world and its diversity of operations also compares favourably to BP. As such, an investment in Shell can be seen as a little less "racy" than that in BP. That is certainly good. However, does less "racy" means less valuable? Not really.

Solid P/E Ratio

The predicted EPS predictions for Shell are a bit inconsistent (or even erratic) for 2015 and 2016. Here is what it looks like for 2015:

EPSP/E Ratio
Difference (%)187.52

The consensus EPS provides for a not too bad P/E ratio of 11.3. However, the spread is clearly very large indeed at nearly 190%. This means that I have little faith in the EPS predictions offering me a fair perspective in the short run.

This is repeated for the 2016 predictions (naturally):

EPSP/E Ratio
Difference (%)124.85

That being said, these figures suggest a more positive outlook going forward. Indeed, this is the timescale I am thinking: 2016 and well beyond. As such, with a stabilising (and potentially growing) oil price I expect Shell to continue to show the strength and resilience of its balance sheet.

Of course, such a wide difference in predictions is of concern. However, it is par for the course in oil stocks. Even when I had bought into BP back in January last year (well before the oil price rout) the difference between analyst predictions had been a comparatively high 33% and 49%. In reality, when your business relies of fickle commodity prices, uncertainty in earnings is to be expected.

Dividend Strength?

Of course, for many oil stocks join their portfolio for one main reason: dividend yield. This is no different for Shell. Shell has famously grown (or held) their dividend since the Second World War. Going forward, the predictions are that this will be retained.

For 2015 and 2016 analysts expect a dividend of 188 cents and 191 cents. This is a frankly disappointing growth of 0% and 1.6% for this year and next. Not great. However, assuming it is right it would still leave my holding yielding 5.74% for this year and 5.83% for next year. This is of course excellent.

There is of course, the possibility of a cut on the horizon. I don't expect it, however, as consensus EPS estimates would leave the dividend covered 1.5 times by earnings for 2015 and 1.75 times for 2016. Not a huge margin for error, but equally pretty solid. Of course, all this could change with the oil price.

Despite all these possible issues, I don't expect Shell (unlike BP) to seriously consider cutting the dividend except in the worst circumstances. A record like their's is not set aside lightly. BP's is more likely to be cut as they have recent form in this regard and their balance sheet looks far weaker.

That being said. Even if a cut did occur (say by a third to around 124 cents) it would still be yielding 3.8% which I consider still pretty generous.

Other Considerations

Other considerations which for me are in Shell's favour are that it has a clearly highly capable management team. What is more, according to my calculations Shell has an excellent debt to equity ratio of about 0.25. Similarly, it is trading a slight premium to its book value (about 15%). To me this seems reasonable despite the fact that clearly their heavy asset sales (as with BP) will affect this figure in the future.

Place in regards my goals...

Shell does fit rather nicely within my goals for 2015. First, clearly the yield should help me towards my goal of £800 in dividend income throughout the year with it predicted to contribute about £43 in additional income. What is more, with a yield of about 5.75% it should positively contribute to providing me with a portfolio yield of 4% or more.

Similarly, as a new holding, it pushes me towards my goal of having between 25 and 30 holdings by the end of the year. I now have 22 holdings in total.

In addition, thanks in part to the fact that many do indeed follow the advice to "never sell Shell" it also has a low Beta at around 0.7. This is great and will help me retain a portfolio beta of 0.85 or less by the end of 2015.

Also, being a larger purchase size (like Old Mutual last month) than most from 2014 it should hopefully help contribute to the lower transaction costs I am aiming for this year.

Oevrall, I am very happy with my new purchase of Shell. In the short term I expect it to continue to be pounded somewhat. However, over the long term I expect it to be a valuable addition to my portfolio.

[Creative Commons image reproduced from Flickr user .Shell]

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