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Shell: positive news on the dividend is a reason to hold the shares

Daily Telegraph

Questor attended Shell’s strategy presentation on Tuesday and the messages were generally positive, especially for dividend seekers.

 By Garry White

Royal Dutch Shell B

Questor says: HOLD

Shell said last year that it would raise its first-quarter dividend by 5pc and the company’s chief financial officer, Peter Voser, confirmed that its policy of raising dividends in line with inflation is to be maintained. Mr Voser will become the group’s chief executive later this year when Jeroen van der Veer retires. 

Shell will maintain its dividend policy by borrowing. The oil group currently has a low gearing ratio of 6pc, so its balance street is strong enough to do this – for now.

The company’s board members declined to give any sort of forecast for the oil price, which is probably quite sensible, but Mr Voser noted that, should the current oil price and dividend policy be maintained, this will imply an increase in gearing to above 20pc by the start of next year.

The nearest that Mr van der Veer would come to an oil-price forecast was saying that he expected the oil price to remain “volatile”.

This dividend policy is entirely reasonable with the group’s strong balance sheet. BP’s current gearing is already at this 20pc-plus level but, should the oil price stay low, whether this can be maintained is open to question.

However, it must be noted that Shell is the only oil major that has given a commitment to raising its dividend this year.

The company has spent more than $68bn on dividends and buy-backs since 2000 and said at the meeting on Tuesday that it would spend $10bn this year making dividend payments.

Another important issue was the company’s production. In 2008, the group’s key reserve replacement ratio fell to 95pc from 124pc in the previous year. The reserve replacement ratio is rate at which oil that has been pumped over the year is replaced by new oil discoveries. This is below BP’s reserve replacement level, which came in at 121pc last year.

Shell is currently developing projects that could add one million barrels of oil to production each day. However, because Shell’s oil fields are relatively old, the rate of production is declining at around 5pc a year. This means that the company’s has to find oil equivalent to 5pc of its reserves just to stand still.

The company pointed out the ratio looked better taking a three-year view. The group’s reserve replacement ratio between 2006 and 2008 came in at a much-better 126pc. The cost of finding new oil in the period also came in at a competitive $2 – $3 a barrel. Total net reserves stood at 11.9bn barrels of oil equivalent at the end of 2008 – virtually unchanged from the same point in 2007.

The company also hopes to benefit from falling costs. Shell embarked on very few new projects in 2007 and 2008, when costs were at their peak, but said it will take advantage of falling costs over the next year to invest in extra production offering good value.

The company is not seeking to raise its top-line production figure at any cost. In fact, this was mentioned a number of times in the presentation, with “value not volume” emerging as a major theme. The company will maintain investment in 2009 at $31bn-$32bn, focusing on its “value” proposition.

Shell accepted that production may slip again this year, but reiterated its target for annual production growth of 2pc – 3pc out to 2012. This is ahead of BP’s production growth target of 1pc to 2pc.

The group also noted its recent investment in gas operations meant production of gas around 50pc of total production and that a significant proportion of its gas sales were in long-term contracts and so were not subject to fluctuations in the spot price of gas.

Mr van der Veer also noted that security problems in Nigeria had been a challenge, and trimmed production growth estimates for the region. However, he argued that when you take BP’s upsteam portfolio as a whole, that there was a good spread of technological and geographical risks. The portfolio is balanced, he argued.

The current prospective dividend yield for December 2009 is 7.6pc. This can be regarded as safe this year following the board’s statement. However, as with all oil companies, should the oil price remain low for an expended period of time, it will be at risk. When this prospect was put to the company’s management, they pointed to an increase in operational cashflow next year, as new oil project come on stream and the reduction in its cost base expected over the next year.

However, Questor reckons that the current dividend policy will be at risk next year should the oil price fall any further and stay there.

When Questor last looked at Shell shares it was argued that the dividend was attractive, but the shares were a hold because of the flat production profile. Questor likes the dividend statement, but with the group only forecasting production growth out to 2012 – a relatively short time in the oil industry, some questions remain. On balance, Questor maintains a hold stance.

Note: If UK investors want buy Shell shares they should buy the ‘B’ class.

Dividends paid on class ‘A’ shares have a Dutch source for tax purposes, which means they are subject to Dutch withholding tax. Dividends paid on class ‘B’ shares have a UK source and are therefore not liable to Dutch taxation laws.

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