Investors in Royal Dutch Shell (LSE: RDSB) have had a bad year. The Shell share price has now fallen by more than 50% in 2020, thanks to a spectacular oil market crash.
Thursday’s half-year results didn’t do much to improve investors’ mood. Adjusted earnings for the period fell by 60% to $3.5bn and Shell reported a statutory loss of more than $18bn.
Things look grim, but the half-year numbers were actually better than expected. I don’t think shareholders need to panic. In fact, I think Shell’s share price could offer decent value at current levels.
Profits are better than expected
Shell’s profits for the first half of this year are dominated by the impact of a $21bn impairment charge. What this means is that the company has decided future oil and gas prices are going to be lower than previously expected. As a result, management have cut the value of some of the oil and gas assets on its balance sheet. This is why Shell reported an $18bn loss for the first half of the year.
This is a disappointment, but it’s worth remembering this is an accounting charge, not a cash loss. I think that a better way to look at Shell’s performance in this difficult period is by focusing on underlying profits and free cash flow.
Shell scores quite well here, in my view. Adjusted earnings for the second quarter were $638m, while first-half earnings clocked in at $3,498m. These numbers were ahead of analysts’ forecasts.
The secret here is that Shell and the other big oil and gas firms all have large in-house trading divisions. These can generate big profits during periods when the oil price swings wildly. That’s what seems to have happened in Q2.
Cash flow should support Shell’s share price
If you’re investing for dividends, then one of the first places you should look is at a company’s cash flow statement. Ultimately, if a company isn’t generating enough surplus cash to pay its dividend, then the dividend might need to be cut.
Shell stunned the market in April by cutting its dividend for the first time since World War II. But this week’s accounts tell me that the group’s cash generation is still pretty solid.
Free cash flow during the first half of the year was $10,050m, excluding one-off payments for asset sales. Impressively, that figure is actually slightly higher than during the first half of 2019, when so-called organic free cash flow was $9,559m.
Annualising this number suggests to me that Shell could generate around $20bn of free cash flow this year.That would value the stock at just six times free cash flow – not expensive at all.
Why I’m holding onto my Shell shares
I don’t think anyone is pretending that Shell is a growth business. But it does have many large oil and gas fields with fairly low operating costs. I expect these to remain big generators of cash.
Rather than recyling all of this cash into new fossil fuel assets, I expect Shell to spend increasing amounts on renewable investments and shareholder dividends.
With the stock trading at 1,100p, Shell’s dividend yield stands at around 4.5%. It’s lower than we’ve become used to from Shell, but I think this could be a good entry point for a dividend investor.
