In arguing for a break-up of Shell, Dan Loeb, the activist investor and chief executive of Third Point, the hedge fund, hasn’t told shareholders in the oil company anything they didn’t already know. The competing demands on cashflows from renewables investment and shareholder returns mean that investors have refused to award the stock much credit, despite booming commodities prices.
A forward enterprise value of 4.3 times earnings before tax and other charges is above the lows of the commodities rout of around 2015, but is below the average market valuation in the years since. That’s a discount to oil and gas pure plays such as Chevron or ExxonMobil, while all three are dwarfed by the price tags attached to renewable energy groups like Orsted, the offshore wind generator.
Investing in oil majors is untenable for some. For others, the attractions of a beefy dividend and share buybacks win out, but the diversion of cash away from shareholders and into greener assets is frustrating.
The short-term rationale for sticking with Shell is clearer: cash generation looks solid enough, with cash from operations at almost $37 billion in the first nine months of the year and free cashflow of almost £30 billion. For the full year, cash generated by the business is forecast by analysts to be $47.4 billion against capital expenditure of only $20 billion this year.
Deleveraging is also on track, with net debt below the $65 billion ceiling at which the company said that it would increase returns again. The taps were switched back on share buybacks in the second quarter of this year and a further $1 billion is targeted for the fourth quarter. An ordinary dividend of 1.29 cents a share is forecast for this year, equating to a potential dividend yield of 5.6 per cent.
Advertisement
Yet in the longer term the outlook for returns becomes less certain. Shell’s new target to halve its operational emissions on 2016 levels by 2030 brings it into line with a Dutch court ruling in May. Note that it does not include “scope 3” emissions, which account for 90 per cent of the group’s total emissions. It aims to be net zero by 2050.
Achieving those goals potentially constrains earnings growth. Increasing clean energy output and earnings from customer-facing businesses, such as charging electric vehicles, is one lever, but those revenue streams still account for a minority of the group total. The upstream and oil products divisions accounted for just over half of operating cashflow during the third quarter of this year.
Liquefied natural gas, which sits in Shell’s transition strategy pillar, might be less polluting than coal, but Shell’s targets don’t use coal emissions as a benchmark but the shape of its portfolio of assets. That could limit growth in liquefaction volumes, analysts at RBC Capital say.
Divesting polluting assets is a quick way of cutting carbon intensity and boosting cash; the $9.5 billion sale of its oil operations in the Permian Basin in North America in September will produce $7 billion for shareholders next year.
The legal precedent set in the Netherlands, which applies worldwide, is a more fundamental problem for Shell. The potential for even tougher curbs on carbon emissions being imposed is obvious enough to the group and it’s still appealing against the ruling in the Hague.
Advertisement
Third Point’s call for a spin-out of Shell’s cleaner business units nods to moves elsewhere in the sector: Eni, of Italy, and Repsol, of Spain, are said to be mulling separations of their renewables businesses.
Scepticism towards Shell’s strategy seems unlikely to dissipate any time soon.
Advice Hold
Why The longer-term viability of cashflows is compensated for by a cheap valuation and good dividend in near term
LXI Reit
You could argue investors are too hung up on dividends and are not focused enough on the potential growth to be made by companies parking cash elsewhere. LXI Reit, a FTSE 250 constituent, has done a decent job of boosting its asset value and a generous dividend. Against an annual target of an 8 per cent total return, it generated an 8.6 per cent increase in net asset value, including dividends, over the first half of the year alone.
Advertisement
The real estate investment trust lets a portfolio of 171 commercial properties to 70 tenants around the country. Food shops and essential retail account for about a fifth of the portfolio by value, with leading tenants including Aldi and Lidl. High-flying industrial property is the landlord’s second largest sector.
The idea is to not to rely solely on making acquisitions, where competition in sought-after corners stands to drive down returns. It has forward-funded the development of about 40 per cent of its assets, focusing on smaller plot sizes in which large, income-hungry institutional investors are less interested. A further 30 per cent of the portfolio are properties where the tenant has completed a sale-and-leaseback with the group, a strategy pursued by supermarket occupiers.
An annual dividend of 6p a share is targeted for this financial year, equating to 4.1 per cent at the present share price. How secure is that? Well, rent collection was 100 per cent for the past two quarters. There’s an element of inflation-linkage to the dividend, too. About three quarters of rent is linked with RPI or CPI inflation, with a further 21 per cent having fixed rental increases.
LXI boasts a long average lease length of 23 years. Of course, that means nothing if the tenant goes bust or launches a company voluntary arrangement in which the rent is cut. As a landlord of Travelodge, the group was not immune to the latter, although it managed to recoup potential losses to its rental income by cutting a deal with the budget hotel chain to hand over unused land for free.
Shares trading at a 5 per cent premium to forecast NAV at the end of March next year leave growth potential priced-in for now.
Advertisement
Advice Hold
Why Attractive and inflation-linked dividend
