Does size matter?
Of course it does, and Royal Dutch Shell (LSE: RDSB) knows all too well why that is the case.
Royal Dutch Shell’s (Shell) size is undisputed. Created by the merger of Royal Dutch Petroleum and UK-based Shell Transport & Trading, it is the second largest company in the world in terms of revenue. Shell also topped the 2013 Fortune Global 500 list of the world’s largest companies. A quick search online shows it has operations in over 90 countries, and has 44,000 service stations worldwide. It’s enormous.
So is it actually too big? CEO Ben van Beurden says it is.
You see, this is where being able to think outside of the box, as a CEO, is crucial. The easy, or at least the most straightforward, option for a CEO is to simply ‘grow’ the business. That means expanding, which involves: more capital expenditure; more plant and equipment; more oil; more products; more staff; etc. Where does that ultimately lead to? In Shell’s case, it’s led to growing pains. One growing pain is a dividend that’s been harder and harder to squeeze out (current yield under 5 per cent).
Profit
As always, the leader of a firm should be focused on one ultimate goal: profit. Spending that profit is a secondary, but important, concern. For Mr van Beurden, it means cutting back on scale and size in order to make the business more effective and efficient.
According to the Wall Street Journal, Shell’s chief says he wants to sell around $15 billion worth of assets by the end of 2015. He also plans to cut investment spending to around $37 billion this year (down from $46 billion).
Regeneration
However, it’s not just about slashing and burning. You also need to re-generate. In terms of the oil and gas giant’s fundamentals, the CEO has his sights firmly set on free cash flow. A glance at the quick ratio (0.87) and you can see that Shell could be spending more time generating cash, rather than trying to take over the world.
Show me the money
As an investor, this fork in the road for Shell is crucially important — it also goes to the heart of what it is that makes a stock a worthwhile investment. Clearly, size and scale are important for stability and dividend security. But what happens when this goes too far? This example shows that cash is still king. It’s so important for a business to be able to generate free cash flow; both for growth in dividends, but also to be able to sit back and determine how to best run the business. Getting bigger and producing more won’t necessarily guarantee more profits. Rewarding investors and improving margins, however, will most certainly produce profits.
Importantly Mr van Beurden has also mentioned Shell was eyeing investment opportunities in deep-water oil exploration and production, and in integrated gas projects. It looks like Shell could be changing it spots ever so slightly so it evolves at just the right pace to ensure long-term survival as an oil and gas mega-player. It’s a stock well worth your attention.
