In 2022, oil and gas stocks have been far and away the standout performers in the FTSE 100. Year-to-date, the Shell (LSE: Shel) share price is up 47%. However, investors still remain wary about buying into Big Oil. Here I’ll explain why I believe that Shell, and the broader industry, will continue to outperform the general market in the years ahead.
Gushing free cash flow
In its Q3 results released today, Shell reported earnings of $9.5bn. That’s over double what it reported in the same period last year. EBITDA (earnings before income tax, depreciation and amortisation) was 60% higher, standing at $21.5bn.
Despite these impressive figures, they’re down slightly on Q2 as oil prices have come off their highs of $120, reached earlier in the year.
Growing dividends and buybacks
One of the primary reasons for investing in Shell is for its dividend. When the pandemic struck, it shocked the market by reducing it by 66%. It’s now seeking to woo investors back by steadily increasing dividends.
In Q3, it announced a dividend per share (DPS) of 25 cents, unchanged from last quarter. In Q4, however, DPS is earmarked to rise 15%. If that dividend were maintained, my calculations are that the stock would provide a yield of 4.2%.
Admittedly, Shell’s dividend yield is hardly headline-grabbing. However, the company continues to buy back its own stock at an increasing rate.
Throughout 2022, it’s expecting to buy back $18.5bn of its own shares. Over the next quarter alone, it has earmarked buybacks totalling $4bn. As a result, total distributions to shareholders will be in excess of 30% of cash flow from operations (CFFO). Given that at the nine-month mark, CFFO stands at $46bn, shareholders are been handsomely rewarded.
Commodities bull market
Over the last year, I’ve written extensively about the oil and gas industry. While many investors have given the sector a wide berth, wary about its medium-term prospects, I continue to remain bullish.
Back in June when oil stocks began selling off, I was in favour of taking a contrarian stance. Since then, the commodities sector has bounced back strongly. So where do I go from here?
Since reaching a peak of $120 in June, the oil price has slowly been declining. However, this decline needs to be set in a wider context.
In a bid to increase supply, the US government has been selling off its strategic petroleum reserves (SPR) at a record rate over the past year. At this rate, the SPR will be zero in 18 months.
Elevated levels of inflation are forcing central banks to push up interest rates. As the world economy heads into a likely deep recession, demand will undoubtedly take a hammering.
Yet despite these two huge macro forces bearing down on it, the oil price continues to hold up well. The reason is that inventories remain extremely tight. It’s the lack of supply coming online in the years ahead that’s the real driver for oil prices to remain elevated.
Levels of capital expenditure across the industry remain depressed. Solving this issue will involve international consensus around energy security. Until addressed, I expect the Shell share price to continue to perform well. That’s why I recently increased my position in Shell.
