I started my dividend growth investment journey in September 2014 and Royal Dutch Shell’s stock was one of the first I bought for my portfolio.
But as you know, it’s been quite a ride since then!
Firstly we had the oil crisis in 2016, because Saudi Arabia decided to start a price-war. In response, Royal Dutch Shell bought BG Group Plc for a whopping 70 bln US dollars.
Secondly we had the COVID-19 outbreak which led to a negative oil price for the first time in history. The impact on the cash flows was a bit too much for Shell and that’s why they decided to cut their dividend for the first time since world war II.
In response to that the share price dropped all the way to 10 Euro per share while it was trading between 20 and 30 Euros for the majority of the last decade.
I can tell you, to experience all of this as an investor you must almost have a mental disability to keep your head cool. I can’t even count how often I have heard that “oil is dead”, “you’re a fool to invest in oil stocks”, “no index funds will want to have Shell in their ETF”, “Tesla will disrupt the oil industry”, etc… Believe me, I truly think I have heard it all.
But hey, here I am in October 2021 and I’ve never sold a single share of Royal Dutch Shell stock. To the contrary, I even increased my position this year by adding another 100 shares.
So why is this? Did I fell in love with the stock? Or is there a more rationale reason behind it?
That’s actually why I decided to write this post, because these were some of the questions I was asking myself lately. I rather do my homework in the midst of euphoria rather than at the bottom of a cycle. The sentiment is much better now to not be influenced by all the noise and opinions of investors being stressed due to fear.
I mean, the same with Alibaba few weeks ago. I never heard someone talking about the VIE structure a year or so ago when $BABA was a very popular stock, but suddenly people out of no-where were talking about this risk.
It just shows you that fear was overdone and since then the news laid down a bit. Nothing changed in the VIE related risk though! It’s still there, it’s just not in the headlines this week which allows the stock price to silently recover a bit.
Anyway, back to Shell. In today’s post I will share a few thoughts about why I’m still thinking that Shell is a good investment. At the same time I will show you the power of consistent dividend reinvestment and the compounding effect it gives.
1. My thoughts about Shell’s future
Let’s get straight to the chase: I think that Shell is one of the best Oil Majors positioned for the upcoming energy transition. In my opinion Total Energies is still better, but Royal Dutch Shell stock would be my second choice from that point of view.
So why do I think this?
Well, we’re seeing it play-out right in front of our eyes with the current energy crisis in Europe.
Many European countries created several years ago policies which are very aggressive to reach CO2 reductions to fight climate change.
Wind parks and solar panels are popping up everywhere. France continues to invest in nuclear energy while Germany doesn’t want nuclear energy and brown coal at all. The Netherlands is effectively closing down their gas reservoirs due to the impact on society in the Nord part of the country.
Fast forward to September 2021: mother nature decided to not blow so much wind right now, brown coal is being burnt like there’s no tomorrow and the energy bills for consumers are shooting through the roof.
So what does this mean to me?
Countries, and especially European politicians, have been very aggressive in their policies with going into clean energy. I mean, I’m not challenging the need for it, because in my opinion its very much needed!
However, it’s not easy to do this and now we’re in a bit of trouble.
And that’s where Shell comes around the corner, because the acquisition of BG Group in 2015 was exactly for this reason. Ben van de Beurden bought BG Group, because of it’s gas reservoirs. He saw that society wants to be less dependent on Brown Coal and Oil to reduce CO2 and he also saw that there’s no real alternative yet to meet the needs from society (i.e. population and middle class growth in India).
What he did see is that Liquid Natural Gas is the perfect transitionary commodity, because it comes at a much lower CO2 output than Coal or Oil and it can be “pretty easily” shipped across the globe.
And from that point of view, gas is an energy source which is and can be used much more to create the electricity we consume in our houses. At least until we have more reliable energy resources for our smart grids. A lot of investment in innovation is still required to be able to have clean energy at scale. In my opinion we still need to fix the issue of having a day with no wind and sun.
To me, I agree with Ben, Natural Gas is an ideal transitionary energy source and Shell is well positioned being the leading NLG supplier of the world (20% of supply).
At the same time it has still a large oil reservoir which generates most of their cash flow. Besides that it started to do quite a bunch of small investments and partnerships to tip their toes into the business of clean energy.
This is also the reason why I’m still quite bullish on Royal Dutch Shell stock in the short- to mid-term.
Long Term prospects
I have more uncertainty about the long-term prospects (10 years from now). The reason for that is their oil reservoir, because it has an approximate life-span of slightly less than 10 years.
At the same time Shell is not heavily investing anymore in new oil reservoir discoveries and it recently decided to sell it’s stake in the Permian basin to ConocoPhillips for 9.5 Bln.
The cash proceeds from this transaction will be used to fund $7 billion in additional shareholder distributions after closing, with the remainder used for further strengthening of the balance sheet. These distributions will be in addition to our shareholder distributions in the range of 20-30% of cash flow from operations. The effective date of the transaction is July 1, 2021 with closing expected in Q4 2021.
Source: Shell Investor Relations
I’m not sure yet about the impact of this sale for their oil reserves, so I will pay some additional attention to that in the upcoming annual report.
But yeah, what it effectively tells me is that Shell has 10 years to figure out how to transition into a more carbon neutral and sustainable energy business model.
In my opinion it doesn’t mean that in 10 years from now there’s no need for oil any more, but their capacity to produce the same as what they’re producing today is something I expect to be significantly lower.
But there comes the trick: with what to replace it? There’s so much money to be made with Oil!
From that point of view oil is a perfect commodity. It’s subsurface and the land is owned by governments. That’s truly a perfect incentive for both a country and Shell to gain maximum profits on the sale of oil.
That’s why we see all these joint ventures between Oil Majors and Government controlled companies, decade long production agreements and even the OPEC+ as a legalized cartel.
But if I think for instance about wind: nobody owns wind… This is a problem, because governments can’t easily influence the pricing of wind energy as they don’t control many of the assets and input sources. As an example, individuals like farmers have a lot of freedom to decide themselves to allow for installation of a windmill on their land.
If I think about water: how many dams can you build in a single river? And how many rivers are there in Europe that could generate enough energy to supply Europe without disrupting the shipping & transport industry?
These are just some very simplistic examples which show the differences in pricing power between Oil and the more popular clean energy sources.
And replacing high margin Oil with an equally amount of high margin clean energy is the real elephant in the room when we talk about the long-term prospects of a company like Royal Dutch Shell.
Good news though, the company gets this and I like their strategy to transform into the future. They also seem very good in capital allocation and I expect them to continue to use their excess cash flows:
- to invest in clean energy sources,
- buy back shares,
- deleverage their balance sheet
- making additional incremental and sometimes bold-on acquisitions.
This kind of capital allocation should benefit us as shareholders and allow us to follow a similar path as big tobacco over the last 20 years. Those companies have proven to be great compounders and very shareholder friendly to dividend investors like us.
So time will tell, but I believe that the long-term prospects for Shell still have to be invented to some extent. That’s why I will continue to keep a close eye on their performance over the upcoming 5 years.
But in the meanwhile I continue to be a happy shareholder 👍
These are just my thoughts based on reading a lot of information related to Shell and the Oil & Gas industry. If you truly want to form your own opinion, then I would highly recommend reading the IEA Energy Review 2021 and Royal Dutch Shell’s future scenario’s. Both sources might be biased, so I would also recommend to read some more contrarian researches by other institutes.
2. The power of consistently reinvesting dividends
Now this is where an investment in Shell gets so interesting. Just have a look at the share price development of Royal Dutch Shell stock since 2014:
Just this graph alone would suggest you that it was a very poor investment to make. Though, an optimist would still say that it was at least dead money 😅
But this is where I differ from the majority of investors, because I invest for dividends. I actually like charts like these as long as there’s a quality business behind it.
It allows me to accumulate my position at more attractive levels which fuels my dividend cash flow more than when share price growth outpaces earnings power.
But this is not entirely true in the case of Shell, because earnings have been severely impacted twice during this time period: in 2016 when Saudi Arabia started a price war with the United States and last year when the pandemic broke out.
But this is also the nature of an oil & gas business, because it’s very dependent on their cycles. Oil companies know this and that’s why they talk a lot about “gearing” as it’s a measure of their balance sheet strength.
Anyway, back to the topic of this paragraph. I would like to show you that continually reinvesting my dividends has still allowed me to make a decent return during these years.
Net Cash investments in Royal Dutch Shell stock
As you can see, I bought 620 shares over the last 6 years for a weighted average price of 19.62 Euro and a total of 12.217 Euro. This is a lot of money and I am slightly on a loss from that point of view.
Dividend Reinvestments in Royal Dutch Shell stock
My Dutch broker Binck has always allowed me to reinvest the dividends (after-tax) directly into the company and I’ve done this most of the times (I might have forgotten it few times early on).
This is the overview I truly love, because consistently reinvesting dividends has allowed me to accumulate 103 additional shares (16.6% on cost) in Royal Dutch Shell. These shares are worth 2000 Euro and they pay me an annual dividend of 85 Euro at the current currency exchange rate. Or in other words, one additional share reinvested per quarter.
From a return point of view you could say that the value of my position increased by 15% over these years. This is not that much off course compared to the S&P500. But just remember that I didn’t buy my whole position at once back in December of 2015.
Actually, almost half of my position was acquired just last year. That’s in my opinion really not that bad!
But what I also like is that the company is paying me a current dividend yield of 4.28% even though it slashed it’s dividend by 66% last year.
And it doesn’t stop there, because I still think that there’s lot of room to grow the dividend in the upcoming years. Especially if we will see oil prices around these levels for several years longer.
Just buybacks alone will allow the company a growing dividend to it’s shareholders without the need to hike the dividend in absolute numbers.
So all in all, this example is truly the power of compounding for me.
I made money on an investment while there were 2 severe crashes and a severe dividend cut. The share price has yet to fully recover, but in the meanwhile reinvesting the dividends has definitely done the heavy-lifting for me.
You just gotta love a cyclical business 🤗
Royal Dutch Shell stock: what I’m doing going forward
Royal Dutch Shell is nearly a full position for me, so I’m not intending to buy any additional shares from the money I have available as part of my savings rate.
However, I would like this position to organically grow to 800 shares via dividend reinvestment. By that time it should give me an approximate annual dividend income of 1000 Euro per year based on the assumption that Shell will continue to grow their dividend over the upcoming few years.
I will stop reinvesting dividends when it reaches that threshold and I will start redeploying the dividend income elsewhere (non-Energy stocks). Probably I will reach that stage somewhere early on in 2024.
At the same time I will continue to keep a close eye on their strategic execution, because I might sell my position in the future in case it fails to transform into a similar profitable business going forward.
3. Last words of wisdom to myself
I honestly don’t think that I’m in love with Royal Dutch Shell.
It rather triggers the feeling of being contrarian in me. Not sure if this is a good character trait as an investor, because it might mean that I’m still biased and not fully objective.
Hence, I will still need to dig a bit deeper into this to fully understand this psychological behavior in me. At the same time it reminds me that investing is more about psychology than being intelligent.
But what do you think, is this contrarian mindset actually good or bad for an investor?
European Dividend Growth Investor
Interested in hearing my reflection on the oil majors? Check out the below video where I look into their key metrics (i.e. reserve life, debt ratio).