Not many companies are big enough to move the FTSE 100 single-handed. One of the few that can is Royal Dutch Shell (LSE: RDSB). Shares in the oil and gas giant are down 5% at the time of writing, after the firm reported a 25% drop in half-year profits. This drop has knocked a few points off the FTSE 100, despite gains for smaller firms.
Should you avoid Shell after today’s news? Or is the RDSB share price fall providing income investors with a good buying opportunity?
What’s happened?
Shell’s net profit for the first half of 2019 fell by 25% to $8,999m. Although production rose during the period, lower prices for oil, gas and chemicals put pressure on profits.
The firm also reported lower profits from asset sales, which boosted earnings last year. If we ignore the effect of this and certain other one-off items, Shell’s half-year profits were 13% lower than last year, at $8,763m. A 25% drop in profits would be a serious concern for some businesses. But we need to remember Shell makes most of its money from selling oil and gas.
Market prices for these commodities go up and down all the time. Last year, Shell reported a 135% rise in half-year earnings. This year they’re down. As a shareholder, this doesn’t concern me — I see this as business as usual and I’m reassured by the group’s production growth.
Still a cash machine
Shell’s management is actively taking steps to position the company for a future when oil consumption is lower. The firm is maximising cash generation from its oil operations while limiting spending on newer projects. The upshot of this for shareholders is that the firm is generating a lot of spare cash. Free cash flow was $10,873m for the six months, nearly $2bn more than reported profits.
This is a bit technical, but what it indicates is that Shell is spending less on new projects than it’s recording as depreciation on existing assets. Put simply, chief executive Ben van Beurden appears to be shrinking the business. This approach is also reflected in his policy on shareholder returns. Rather than investing too heavily in new projects, Shell is midway through a plan to return $25bn to shareholders through share buybacks by the end of 2020.
Alongside this, the firm plans to pay out roughly 70% of this year’s earnings in dividends. This gives the stock a yield of 6% after today’s fall — an attractive level, in my view.
It’s all about the future
The big question for investors in Shell is what will happen over the next 10-20 years? The company expects to be a major gas supplier long after oil demand begins to weaken. But it’s looking for other areas in which to invest too, such as the utilities and renewables. The risk for shareholders is that the company won’t find anything that’s as big and profitable as oil.
I don’t know how successfully Shell will reinvent itself. But I think the group is well positioned to evolve and is doing the right things to protect shareholder value. After today’s fall, RDSB shares are trading on 11 times forecast earnings with a dividend yield of more than 6%. I continue to see this stock as an income buy.
