Is Shell the ultimate value stock?

One activist investor thinks so, and his plan to unlock it makes sense

“Usual pile of baffling and conflicting financial nonsense that nobody understands. Anyway, the Debt is lower” was the verdict from top fintweeter @WheelieDealer on results from Shell yesterday. It’s hard to disagree, mainly because of the huge distortion of the reported figures as a result of the mark-to-market accounting treatment of the derivatives it took out during a year of oil market craziness. Either way the market didn’t like the numbers, with the shares falling over 3% after a good run on the back of the surging oil price.

I’ll come back to the accounts later. In the meantime, it’s easy to see why, whatever the results say, the market isn’t especially enamoured of where Shell finds itself today. Regardless of the gyrations of Brent crude, oil companies including Shell remain stuck between the rock of their core hydrocarbons businesses and the hard place they need to get to – a hydrocarbon free future.

Enter Dan Loeb of hedge fund Third Point Capital which has taken a $750m stake in the Anglo-Dutch oil major. “There is perhaps no bigger ESG opportunity than in “Big Oil”, and specifically, at Royal Dutch Shell,” Mr Loeb wrote in a third quarter update to his investors, noting that Shell is one of the cheapest large cap stocks in the world and trades at a massive discount to rivals like ExxonMobil or Chevron despite having a much more sustainable business mix.

Big oil and ESG are not two things you would naturally associate with one another, but Mr Loeb’s plan makes sense if you think about it – the world needs energy, and big oil has the opportunity to be a major part of the shift to a greener future. And Shell has already pushed further into renewables and transition fuels like liquified natural gas (LNG) than many of its peers, although greener businesses aren’t yet generating the returns of legacy oil. Others across the industry may be reporting better trading right now, grist to the mill of those Shell shareholders who think it should focus on the returns that accompany legacy oil, but their pain is yet to come.

Specifically, Mr Loeb thinks the only way out of it is to split itself into multiple companies. These, he suggests, could include a hydrocarbon business, essentially ex-growth and dividend-centric, and a focused green/transition energy business capable of growing, an approach which would enable it to reshape its business to meet what he describes as the “conflicting” demands of its many shareholders. “Shell has too many competing stakeholders pushing it in too many different directions, resulting in an incoherent, conflicting set of strategies attempting to appease multiple interests but satisfying none,” he wrote.

The type of growth on offer in a pure-play renewables/transition business also has clear attractions – look no further than Orsted, previously Danish national oil producer Dong Energy until it sold all of its hydrocarbon assets and rebranded in 2017. It’s now the world’s largest offshore wind energy producer, and its shares have nearly trebled since then, far better than the 3% annualised returns from Shell over the last two decades. Mr Loeb points out that in Shell’s case such a standalone business would be able to pursue similarly aggressive investment in carbon reduction, and benefit from a much lower cost of capital. “Pursuing a bold strategy like this would likely lead to an acceleration of CO2 reduction as well as significantly increased returns for shareholders, a win for all stakeholders.”

Of course, the scale of the challenge is much greater for Shell, but that it is why a split makes more sense than further asset disposals – “shrink to grow” as Mr Loeb puts it, which Shell has been doing through the disposal of refining and production assets like the Permian gas business, sold for $9bn to ConocoPhillips. That’s especially true now that we may have realised that the death of hydrocarbons may have been somewhat exaggerated – at least, the pace of it anyway.

Anyway, there’s enough of an idea here to put this in the ‘special situations’ box and for me to think about a position in the Sipp – not for the short-term activist-driven upside or the $7bn of distributions to come from the yet to complete Permian sale, but on a longer-term view of how Shell may be able to reinvent itself for a cleaner age. How that reinvention happens has been puzzling observers for some time – the answer is becoming clearer, and Shell – with the activist tailwind – could be the blueprint for big oil.

Oh yeah, the accounts. Here’s the simplified story: adjusted earnings in the third quarter were $4.1bn –below consensus of $bn – partly due to a $400m hit from Hurricane Ida (an occupational hazard, surely?) but cash flows were up massively, hence the drop in net debt from $67bn to $57.5bn and a divi held at 24 cents, taking the total 9-month distribution to 65-and-a-bit cents, a 34% year-on-year increase. That pay out – along with the Permian distribution – is still in itself good enough reason to hold the shares, even if the long-held view that Shell’s dividend was uncuttable was shattered last year. But a British Gas-style split is where the real long-term value is likely to be found – let’s hope Shell is serious about engaging with the activists.

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