The past few months have been extremely turbulent for U.S. stocks, sending uncertain investors flocking to the relative safety of dividend stocks. Fortunately for dividend stock investors, Royal Dutch Shell (NYSE:RDS.A, RDS.B) offers a world-class dividend, impressive free cash flow growth, and a long-term transformation story as well.
Royal Dutch Shell Stock Cash Flow
The oil market is not be where investors typically think to find growth stocks. Royal Dutch Shell stock is certainly an exception when it comes to free cash flow. When oil prices were near their lows in 2016, Shell was aggressive, with a $53 billion buyout of BG Group. At the time, the deal pushed Shell’s debt balance to around $80 billion, but the company laid out a long-term debt reduction plan that included divesting $30 billion in assets within two years.
As of the most recent quarter, Shell had completed $28 billion of those $30 billion in divestments. It has also announced another $4 billion in divestment deals and plans to complete an additional $5 billion in sales by the end of 2020.
While Shell is making steady progress in reducing its debt, its cash flow is skyrocketing. Shell’s cash flow more than doubled from $3.6 billion in the third quarter of 2017 to $8 billion in the most recent quarter. Free cash flow per share is up 245.3% since the beginning of 2016, yet the stock is up just 32.6% during that time due to a persistently weak energy sector.
Slow And Steady Oil Market Recovery
The oil market has been choppy in the past couple of years, including a large sell-off in Q4 after new sanctions on Iran failed to have the impact on global supply that many investors had anticipated. However, a longer-term look at oil prices shows a volatile market that is trending in the right direction. WTI crude oil prices are up 35% overall in the past two years, and consensus Wall Street expectations for 2019 suggest an average price of around $62.50/bbl, another 17% upside. Sure, it’s a far cry from $100 oil, but the trend is heading in the right direction.
In the meantime, Shell investors are getting paid handsomely to wait. After the recent bout of market weakness, Shell stock now pays a 6.1% dividend yield, a payout that would easily rank as one of the 20 highest in the S&P 500. For U.S. investors, it’s also better than the 4.5% Exxon Mobil (NYSE:XOM) yield and the 4.0% Chevron (NYSE:CVX) dividend.
Shell’s dividend and its business are also extremely stable and safe. In the most recent quarter, Shell generated about $8 billion in free cash flow, more than double the $1.8 billion it needed for its dividend and the $2 billion it devoted to share buybacks.
If it’s not cash flow growth, dividend weakness or concerns over lower oil prices that are holding Shell back, its poor investor sentiment about fossil-fuel stocks. Investors see oil, gas and coal as businesses with no future, despite the fact that firms like Woods Mackenzie are predicting global oil demand will continue to rise for roughly another two decades thanks to demand growth from emerging markets such as China and India. Perception is reality when it comes to investor sentiment. If investors believe oil has no future, the earnings multiples of companies like Shell will continue to shrink.
Fortunately, Shell has recognized that it needs a makeover if it wants to survive in the long term. Last year, Shell management committed to investing up to $2 billion per year in renewable energy projects. If it sticks to that goal, the company may invest nearly $40 billion in renewable initiatives by the time peak oil demand rolls around in 2036. With that much time to develop technology to shape the future of the business, Shell may be in the perfect position to make a smooth transition to the next era of global energy.
The Bottom Line on Royal Dutch Shell Stock
Everything seems to be going in the right direction for Shell except its share price. Cash flow is spiking, the dividend is growing, debt is shrinking and the company has begin its transition to alternative energy. However, poor perception of the energy sector and impatience about the pace of the global oil market recovery has led to Royal Dutch Shell stock dropping 16 percent in the past two years. At some point, sentiment will shift and the market will recognize RDS stock is a long-term buying opportunity.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned stocks.