The year 2018 was full of ups and downs for the energy sector, and share prices of most of the oil super majors tumbled. Crude prices started the year above $60 a barrel, touching multi-year highs of more than $76 in early October before hitting a deadly downdraft since mid-October.The prices plummeted below $45 in late December amid weakening demand, supply glut and concerns of economic slowdown. Nonetheless, the rocky crude market could not deter the Big Oil companies to deliver stronger year-over-year profits in the last reported quarter. Notably, even amid gloomy market conditions, the European energy giant Shell (RDS.A - Free Report) not just managed to retain the top position among peers in the free cash flow (FCF) parameter, the metric recorded remarkable y/y growth of 43% in 2018.
While the Anglo-Dutch giant is riding high on FCFs, what’s surprising is the fact that the firm has kept its dividend frozen for 20 consecutive quarters. With crude price environment gradually improving on the back of OPEC-driven supply cuts and healthier demand prospects, is a dividend hike around the corner for Shell? Further, with all its peers raising payouts amid improving results, should Shell follow the trend?
Let’s delve deeper to analyze the overall scenario of the company.
Robust 2018 Results
In 2018, Shell generated net earnings of around $23.3 billion, up 80% y/y. The company’s integrated gas business’ (consisting of BG Group activities) adjusted earnings grew 78% y/y on the back of pricing and volume gains. The upstream profits during the year also skyrocketed 119% owing to higher realizations. While downstream profits declined y/y, cash flow from the segment increased 12%.
Overall cash flow from operations, which is an important metric to gauge the financial health of the firm, came in at $53.1 billion in 2018, marking an impressive 49% growth from 2017. The Zacks Rank #3 (Hold) company has benefited from its integrated model, and generated enough cash for paying off debt, along with funding capex and dividend payments.You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Impressive Transformation into a Cash Generating Machine
While crude downturn hugely impacted Shell’s profits in 2015 and 2016, the BG Group buyout increased its debt levels considerably. The FCFs of the company dipped more than 70% y/y in 2015 and eventually became negative in 2016. However, the Shell’s strategic initiatives, including cost discipline and aggressive divestment program worth $30 billion along with eventual crude rally, helped the company to emerge from the slump and shore up its financials. In 2017, Shell generated FCF of $27.6 billion and the level further increased to $39.4 billion last year.
Shell’s Dividend Prowess
While Shell is not a dividend aristocrat, it is definitely one of the most attractive dividend stocks in the energy sector and the second highest dividend-yielding stock among the Big Five Oil companies. With an attractive yield of 5.07%, it is only second to BP plc (BP - Free Report) , which flaunts an impressive 5.57% yield. Notably, Shell has never resorted to dividend cut since the World War II, manifesting the strength of its business model.
Even during the three-year crude slump since 2014, Shell did not reduce its dividend. It rather started offering scrip dividends to its shareholders, instead of full-cash dividends, to ward off cash flow problems. With the recovering energy market and the company’s strategic initiatives paying off well, Shell aborted its two-and-a half-year long scrip dividend program from the fourth quarter of 2017.
Although the company is generating robust FCFs, it is still not hiking its payout. While its peers including BP, Chevron (CVX - Free Report) , ExxonMobil (XOM - Free Report) and TOTAL are boosting shareholders’ values via dividend hikes, Shell remains the only one of the big five oil companies that has kept its dividend unchanged even amid soaring income and cash flow generation.
With cash flow rolling in for the company and all its peers having hiked their dividends of late, is this strategy of keeping its dividend frozen for so long prudent for Shell?
Dividend Hike Takes a Backseat Amid Other Priorities
While management anticipates generating FCFs of around $30 billion in 2019 and 2020 each, a dividend increase does not seem imminent. Instead, using its excess cash in project ramp-ups and tapping into new opportunities in the upstream segment will aid the company in growing output. As it is, the company is on the prowl for additional acreage in the Permian Basin and intends to lift its output in the region by 30% every year. As Shell’s Permian position is relatively modest, given the scale of the company, it is looking for profitable acquisition opportunities to solidify its acreage in the region. Shell is reportedly eyeing to acquire the privately-owned Endeavor Energy Resources for $8 billion.
In addition to revving up Permian strength, Shell is also targeting to become the biggest electricity power company within the next 15 years. It will invest up to $2 billion per year in the New Energies division, primarily to enhance its position in the power sector, wherein it envisions 8-12% annual returns.
With such ambitious plans, the company is more likely to concentrate on growth opportunities rather than rushing into dividend hikes. Shell’s top priority has always been debt reduction and it is is more likely to utilize cash flows to further reduce its leverage.
We don’t necessarily believe that the company requires hiking its dividend just for the sake of pleasing investors or following peers. Even though the company has not hiked dividend, it has one of the best dividend yields and fares well on the reliability factor, which is particularly important for dividend stocks.As it is, the company’s massive $25-billion stock buyback program has given investors a reason to cheer. Hence, we don’t particularly believe that the company needs to hike its dividend now.
In fact, it would be judicious for Shell to reinvest its cash in lucrative growth opportunities, which would result in stronger returns in the future. Particularly, while divestment strategies of the firm have definitely led to debt reduction and boosted cash flow, these have also reduced Shell’s oil and gas production. Notably, the company’s total upstream production in 2018 reduced 2% from a year ago.
It also expects first-quarter 2019 output to decline amid asset sales and natural decline of its oil fields. While Shell’s peers are ramping up their output levels,thanks to strong pipeline of projects, Shell lags in this regard. Hence, a dividend hike should not be one of the top priorities for the company at the moment. Instead, it is advisable for the company to reinvest in lucrative opportunities, achieve its targets and become a financially healthier investment option.
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