Global energy giant Royal Dutch Shell's (RDS.B) stock is offering investors a very attractive yield of 5.1%. That compares to the less than 2% available from an S&P 500 Index fund. Add in improving oil prices, and you can see why investors have gravitated to the stock, pushing Shell's stock price up 7.5% so far this year, around three percentage points more than the advance in the S&P. But a big yield and strong relative performance aren't the real reasons to love Royal Dutch Shell stock.
An odd decision at a bad time
The last four years or so haven't been great for integrated oil and natural gas companies like Royal Dutch Shell. When oil prices started to plummet in mid-2014, energy company results took a huge hit. Shell, for example, saw its top line decline nearly 50% between 2013 and 2016. Earnings tumbled, as well. In fact, in an effort to preserve cash, the company decided to use a scrip dividend, issuing additional stock to those who elected the scrip program so it could limit the amount of cash it was sending to shareholders. During this period it was also focused on cutting costs, just like other oil majors.
However, unlike most of its peers, Royal Dutch Shell decided to take on a huge $50 billion acquisition during the oil downturn when it bought BG Group. This move materially increased the company's leverage at a time when it was dealing with a difficult oil market, a move that troubled many investors. Long-term debt was around $36.2 billion at the end of 2013 and peaked at $86.6 billion in the third quarter of 2016. More than doubling long-term debt during an oil downturn, largely in support of an acquisition, is a bold move, to say the least.
Reading into the acquisition
To assuage market concerns about debt, Shell announced a portfolio reshaping backed by as much as $30 billion in asset sales (with a material portion of the proceeds earmarked for debt reduction). It's inked deals for or sold assets worth around $26 billion already. Long-term debt levels are slowly starting to come back down. And with oil prices having recovered since hitting a bottom in early 2016, investors aren't nearly as concerned about Shell's future or its ability to sustain its dividend (note that it ended the scrip dividend in early 2018).
But it would be a mistake to forget about the huge acquisition Shell made during a downturn. This aggressive decision showed a willingness to use the downturn to bargain-hunt, adding additional exposure to natural gas, viewed as a key transition fuel (more on this in a second), and desirable offshore oil projects to its portfolio. It was something of an outside-the-box move that shows Shell thinks long term.
In fact, in late 2017 Shell CEO Ben van Beurden made an interesting comment during an earnings conference call about how investors should be thinking about the future for his company: "If you invest $25 billion to $30 billion a year in a company with a $280 billion balance sheet, you have a new company every decade." That's roughly the capital spending plan at Shell today. My read on this is that Shell is a company in the middle of a long-term transition.
The big acquisition was part of that, as it has helped Shell increase its already strong position in natural gas. Between 2015 and the first quarter of 2018, Shell increased its liquified natural gas volume sales by 75%. But that's not all the energy giant has been up to.
For example, it recently bought Dutch-based NewMotion, one of the largest providers of charging stations for electric vehicles in Europe. Shell has also been investing in offshore wind farms. This isn't exactly out of the ordinary for Shell, which has been dabbling in wind for a while, but it shows that Shell is clearly looking to a future in which oil isn't as important as it is today. This isn't to suggest that oil is suddenly going to go away; that's hardly true, which explains why ExxonMobil has chosen to double down on its core energy business. And, frankly, most of Shell's transitional moves are relatively small (with the notable exception of that $50 billion acquisition). But Shell is obviously working to adjust today for a future that it thinks will look vastly different than its oil-focused past.
More than just a pretty yield
Royal Dutch Shell's generous 5% dividend yield is certainly something that income investors should like. But the real reason to love Shell is the company's willingness to reshape its business to adjust to the world's changing energy landscape. Its big acquisition during an industry downturn was an example of the direction it's going in, but so are smaller moves like buying NewMotion and building wind farms. Shell is a high-yielding oil and natural gas-focused energy giant today, but you should love it because of its willingness to think long-term -- which looks increasingly like it means growing on the electric side of the broader energy business.