Shell will have to prove ability to preserve returns, Jefferies says
Analysts at Jefferies nudged their target price for Royal Dutch Shell's A shares higher, from 3,000p to 3,050p, telling clients that the company would have to demonstrate its ability to preserve returns even as it invests in its low-carbon businesses, even as they labeled the potential for shareholder returns "compelling".
In its recent strategy update, Shell had de-emphasises upstream as the growth driver, in part as the new Power unit, which had utility rates of return, grew, wkth deregulated markets and low carbon generation expected to competitive and Marketing and Chemicals generating returns that were seen as competitive with upstream.
"Historically, the Upstream business has provided the highest returns and investors may need proof that Shell can increase its return profile as its growth priorities change," Jefferies said.
"The Upstream business will remain the largest cash generator for Shell and will be allocated about 40% of capital spending - it isn't going away. Nevertheless, we believe that growing the return structure while capital allocation to the Upstream declines as a percentage of overall spend is a key risk for the Shell investment thesis."
Nevertheless, in 2019 Shell's return of cash to shareholders was estimated at 9.6%, 300 basis points more than its closest peer and the visibility provided on its returns "distinguishes the stock and we expect further outperformance."
"Other valuation parameters are becoming more strained, with FCF yield at 8.5% on our 2020 estimates vs the European peer average of 9.0%. However, cash returns matter."
Under the oil major's current projections and assumptions, which were line-with its own, Jefferies estimated that on top of the $125.0bn distribution potential for 2021-25, Shell would be left with about $120.0bn in discretionary cash flows for debt reduction and shareholder distributions in 2021-25.
At a compound annual growth rate of 3.0% for the payout and average share buybacks of $6.0bn per year, then the absolute dividend would hold at approximately $15.0bn, equating to an annual average distribution of 8% based on the outfit's current market cap, Jefferies estimated.
Jefferies stuck to a 'buy' recommendation for the shares.