HL SELECT UK GROWTH SHARES
New holding - out of our Shell
Fund changes
HL SELECT UK GROWTH SHARES
Fund changes
Steve Clayton - Fund Manager
6 August 2019
We have recently taken what was, for us, a fairly radical step within the HL Select UK Growth Shares fund. We bought into Royal Dutch Shell, one of the world’s leading energy producers.
Previously we have eschewed exposure to both energy and mining in the HL Select UK Growth Shares fund, so what has changed?
The simple answer is that Shell itself has. The company now has a very different financial profile and looks a much more dependable animal than we can previously recall.
Commodity producers had a torrid time in the aftermath of the financial crisis. Oil prices had been riding high, boosting revenues and the industry, Shell included, had allowed operating costs to rise with it. When energy prices slumped, profits and cash flows became pressured.
Shell’s response was to radically restructure to drive down costs and crucially, to acquire BG Group. BG gave Shell leadership in the global market for Liquefied Natural Gas, and a major new oil production centre in the shape of BG’s deepwater Brazilian oil fields.
The oil price remains a fraction of where it once was, but Shell’s capital discipline is now paying dividends. In recent years Shell has pared back costs, reduced the costs of finding and developing new energy reserves and sold off many of its least efficient assets.
The result is a portfolio that is massively cash generative and with good prospects for production growth. Even at oil prices considerably lower than today’s levels. Shell projects organic free cash flow of around $35bn a year by 2025 and expect to be earning over 12% on capital employed if oil prices stay around current levels.
This should allow the group to return over $125bn to shareholders between now and the end of 2025 but of course there are no guarantees.
The yield on the stock is around 6% presently, and the company themselves are planning to raise the dividend once they near the end of the current $25bn share buy-back programme, although yields are variable and not a reliable indicator of future income.
The $125bn aspiration is equivalent to around half of the group’s current equity market value. With the shares trading on around 10x forecast 2020 earnings, any repurchases of stock will usefully enhance both earnings per share and dividend cover. However, like all investments, Shell’s value and income can rise and fall in value, so investors could get back less than they invest.
Clearly there are big strategic issues facing the energy industry. Shell’s own response has been to plan for a 20% cut in the Net Carbon Footprint of the products they sell by 2035 rising to around 50% by 2050.
This will be achieved by reducing production flaring, disposing of high carbon assets and growing the proportion of gas in their energy mix. New investments into power generation, biofuels and carbon offset schemes complete the picture.
Globally, energy usage patterns are set for big shifts as the world transitions to a lower carbon economy. Coal usage is being reduced in the developed world. Gas, which has a far smaller footprint than oil or coal per unit of energy is growing its share of the energy mix.
Oil will increasingly be used only for transportation applications, with greener power sources displacing hydrocarbons wherever possible. There will however still be substantial demand for traditional fuels in sectors like air transport, and in regions where the local power grids cannot support wide-scale re-charging of electric vehicles, for many years to come.
Demand will remain robust due to the rising numbers of citizens globally. Overall global energy usage is set to rise three-fold over the rest of the century, but this will largely be driven by higher electricity output, where we expect renewables to be the driving force.
Shell earns its money in US dollars, and it has little dependence on the UK economy. This helps to diversify the portfolio. Should Brexit create difficulties at home, we doubt Shell will notice too much. Indeed, if sterling were to weaken further, this would increase the value of Shell’s overseas earnings and help boost the value of its dollar-denominated dividend payments to shareholders.
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