Robert van den Oever: Welcome to Morningstar. Today, I speak with Allen Good, strategist, about Royal Dutch Shell (RDSB) and recent developments at the oil company.
Welcome, Allen. One of the recent developments and one important one is that Shell has decided to reinstate its full cash dividend. Why is that an important measure?
Allen Good: Well, Shell initially went to a scrip dividend whereby they issue shares in lieu of cash. A couple of years ago in the face of falling oil prices it was a move to ultimately preserve cash and fortify the balance sheet. By reinstituting the cash dividend, they are signaling greater confidence in their future ability to generate sufficient cash flow to cover not only capital spending but also the dividend.
So, we think it's important in the sense that, one, shareholders are being remunerated in full cash but also because it's a signal that they are well underway in their cost cutting efforts to ultimately reduce leverage and generate sufficient cash flow in a lower oil price environment.
Oever: The oil price environment at the moment is lower than we had some years ago. We are now in the region of $50 or $60 per barrel and that's not just a price dip, it is a situation that continues for a longer period of time it seems. How can Shell cope with that price level?
Good: Well, we think they are actually situated very well in the current oil price environment. We estimate their breakeven level in 2018, which is actually the level that they can generate sufficient cash flow to cover capital spending and the dividend, at around $50 per barrel. So, while we are well above $60 today, Shell is perfectly comfortable with paying the full cash dividend.
In fact, we think over $60 per barrel they can actually generate sufficient cash flow to repurchase shares. So, as long as oil prices remain above $50 on average, there will be some volatility. We think Shell is perfectly well situated to continue to pay the dividend even in that lower oil price environment.
Oever: You are very positive, and you think that the market somewhat underestimates the value potential that is in Shell at the moment. Can you elaborate a bit more about your views on 2020?
Good: Yeah. So, Shell initially introduced a free cash flow target of about $25 billion in 2020 at $60 oil. We thought the market was overly pessimistic about Shell's ability to achieve these targets and we actually saw them as quite easily achievable given the margin expansion on the upstream, the lower capital spending, the cost reductions they had achieved and then the contributions from the downstream segment. And so, we actually view that target quite positively.
We think the market is coming around to our view given Shell, as I said earlier, has signaled greater confidence with the dividend reintroduction. And so, ultimately, we think these targets are achievable at our oil price long-term assumption of $60 per barrel. That said, we think the market still is overly discounting Shell's cash flow potential and we think this yield is relatively high actually compared to its ability to generate free cash flows. So, we do see additional value in the shares.
Oever: What is your current fair value estimate for the Shell's share?
Good: So, on the Amsterdam shares, we value them about €31. So, this implies about a 15% discount to our fair value. It's actually our most undervalued of the integrated oils currently.
Oever: Okay. Allen, thank you very much for this interview.
