Oil and gas companies aren’t everybody’s cup of tea. A large chunk of the population thinks the likes of Shell are profiting unfairly from people struggling to heat their homes and are ruining the planet. Some investors have taken a stand. Others want a piece of the action.
Investing is primarily about making money and Shell, one of the best performers in the FTSE 100 over the past three years, is known to be very generous about sharing its spoils. In the first half of 2023, the company distributed $11.9 billion to its shareholders through dividends and share buybacks. Big payouts are expected to continue. Each year, Shell aims to return 30 per cent to 40 per cent of the cash it generates and to grow its dividend per share by about 4 per cent. The company wants to make the most of the fossil fuel gravy train and believes that the best way to spend the proceeds is by giving it back to investors.
How much shareholders get hinges largely on the price of a barrel of oil. The higher the valuation placed on the product Shell extracts from the ground, ships, refines and distributes, typically the more money it makes. It’s a volatile business. In the second quarter of 2022, adjusted earnings were $11.5 billion; fast-forward a year and they more than halved to $5.1 billion.
Last year was unusually prosperous. The easing of lockdowns and the invasion of Ukraine caused demand to far exceed supply and prices to rise above $100 a barrel. A return to those levels seems unlikely, but oil prices are increasing again, thanks to production cuts and an improving economic outlook, and are expected to continue doing so into 2024. Opinions on the degree of upside are mixed. Some pundits reckon the closing of losing short positions and the depletion of strategic petroleum reserves in countries such as the Unied States could push oil up to triple figures again. Others claim that the cost of living crisis and a slow economic recovery in China will limit gains. Pretty much everyone agrees that oil will remain comfortably above the level needed for Shell to keep increasing dividends and buying back shares to boost earnings in the foreseeable future.
To judge by the present share price, this outlook is either too bullish or not enough to compensate for other worries. Shell’s stock is changing hands at seven times forecast earnings, a fat discount to five and ten-year averages.
Growing public scrutiny towards all things oil and gas is mainly to blame. Other than the obvious boycotting of “sin stocks” by ESG-led funds (those focused on environmental, social and corporate governance), there are political pressures. The recent energy crisis and climate change concerns are being used by politicians to score points. So far, windfall taxes have barely dented Shell’s cash pile, fuelling calls to exert more punishment and to speed up the switch to alternative power sources.
In many ways, Shell is viewed as a sinking ship. Fossil fuels eventually are going to be replaced with cleaner technologies and the company will need to spend big to have a shot at remaining relevant while continuing to pay investors to keep them on board for the ride. It has been keeping greener investments to a minimum, simply because few offer attractive returns. For now, it’s content with squeezing as much as it can from a detested product that the world desperately still needs.
From a financial perspective, that strategy makes sense. Hydrocarbons will remain a key source of energy for some time and, as long as they do, shareholders probably can expect to be handsomely rewarded, even if the public complains and capital appreciation is limited. If that doesn’t bother you, hold for income.
ADVICE Hold
WHY Generous yield doesn’t look compromised
Coats
David Gosnell, the chairman of Coats Group, and Steve Murray, a non-executive director, spent £107,952 and £47,461, respectively, this month buying shares in the industrial threads manker. It could be a sign that the two insiders believe their employer is undervalued.
Gosnell and Murray’s purchases came shortly after Coats had published its results for the first six months of 2023, which, beyond the headline numbers, were fairly encouraging. A 19 per cent drop in organic revenue and a 21 per cent slide in adjusted operating profit didn’t come as a big shock. Investors knew beforehand that Coats’ core apparel customer base was scrambling to get rid of excess stock and were more interested in how the maker of sewing thread, zips and fasteners, used in everything from clothing to tea bags, seat belts to surgical sutures, responded to this challenge.
The answer was reassuring. Against a tricky trading backdrop, the company grew its market share, kept prices steady, cut more costs and realised synergies from its big moves into the footwear sector. An adjusted operating margin of 15 per cent was a respectable outcome.
There was good news on the pension front, too. The deficit, a serious cash drain in the past, is now close to being fully funded, freeing up money for this highly cash-generative company to invest back in the business, which it has a track record of doing well, or return to investors.
These developments should pay off once demand picks up. Coats sells an essential product, is the market leader in its field by a considerable margin and expects customers to begin restocking again in the second half of the year. The issue is the cyclical nature of its product range. Further setbacks could be in store if inflation remains high.
Economic uncertainty partly explains why the shares trade at a 14 per cent discount to their historical average. Normally that would be acceptable. However, Coats, armed with greater cost management, brighter long-term growth prospects and more cash to splurge, is now a slightly different beast.
ADVICE Buy
WHY Better than the market gives it credit for
