There’s nothing worse than analysts labelling a company ‘dead money’, the slang term given to an investment that’s unlikely to produce a positive return for the foreseeable future.
If the investment truly is dead money, the likelihood of a turnaround is low and investors should consider selling the shares before incurring additional losses.
Unfortunately, the market seems to think that Royal Dutch Shell (LSE: RDSB) is dead money. But is this really the case?
Dead or alive?
There are two main reasons why the market believes that Shell is dead money. Firstly, the price of oil is trading at its lowest level in 12 years and secondly, it’s widely believed that Shell is paying a premium price to acquire its smaller peer BG Group.
Shell’s £40bn tie-up with BG is one of the largest deals the oil sector has ever seen, but it has also become one of the most criticised. The consensus among City analysts is that Shell is overpaying, although Shell’s management remains adamant that the merger will make sense if oil returns to $60/bbl.
Nevertheless, it looks as if the merger is going to take place. But Shell’s existing shareholders face significant dilution if the company’s plan to sell assets and buy back shares issued as part of the deal doesn’t work out. With oil prices where they are today, it’s a buyer’s market for oil assets, which increases the risk that Shell might not be able to meet its asset disposal target.
Moreover, if Shell can’t raise all the cash it needs from asset sales, then the company’s dividend might be at risk. Shell hasn’t cut its payout since the end of the Second World War, so any payout cut would be a significant event for the company.
It comes down to oil
It all comes down to the price of oil. If you believe the price is set to recover, then Shell could be a great investment at current levels. The company’s 9.7% dividend yield is 2.3 times more than the FTSE 100’s average yield of 4.2%, and reinvesting these dividends will turbo-charge your investment returns when Shell’s shares recover.
On the other hand, if you believe that the price of oil will remain below $60/bbl for the foreseeable future, then Shell might not be for you. If the price of oil continues to languish below $60/bbl then Shell’s merger with BG could make the company’s shares dead money. Without a recovery in oil prices Shell will end up overpaying for BG, the company won’t be able to raise enough cash through asset sales to reduce debt and Shell’s dividend payout could be at risk.
That being said, it should be noted that the nine members of Shell’s senior management team together have more than 100 years of oil industry experience, so it’s highly likely that they know how to manage a market downturn like the one that’s taking place today.
Rupert Hargreaves owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.