Is Shell The Ultimate Retirement Share?

Published in Company Comment on 16 July 2012

Will shares in Royal Dutch Shell help you build a FTSE-beating retirement fund?

The last five years have been tough for those in retirement. Portfolio valuations have been hammered, annuity rates have plunged and uncertainty has ruled the roost. There's no sign of things improving anytime soon, either, as the eurozone and the UK economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth, especially if you keep the shares within a tax-efficient ISA or SIPP.

It's no coincidence that the world's most successful investor, Warren Buffett, prefers such companies, and recently invested in a large FTSE 100 (UKX) company that fits the bill perfectly -- you can find full details in this free report.

In this series, I'm tracking down the UK large-caps that have the potential to beat the FTSE over the long term and support a lower-risk income-generating retirement fund. Today, I'm going to take a look at Royal Dutch Shell (LSE: RDSB), whose £140bn market capitalisation makes it the largest company in the FTSE 100 and one of the world's five 'supermajor' oil companies.

In this article I've focused on Shell's class B shares, which pay dividends in pounds and are most commonly held by UK investors. Shell also has class A shares -- Royal Dutch Shell (LSE: RDSA) -- which are virtually identical but pay dividends in euros. The total value of these two types of share gives Shell its £140bn market cap.

Size Matters

Shell is an integrated oil company, which means that as well as extracting oil and gas and selling it on the open market, it also sells refined products like petrol and diesel to consumers. This means that it is not solely dependent on a high oil price to make big profits, although this certainly helps! The link between profitability and the price of oil also explains why Shell's yearly performance is not directly linked to the FTSE 100:

Total Return20072008200920102011Trailing 10 yr avg.
Royal Dutch Shell16.8%-17.4%11.2%22.7%21.0%5.4%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%6.8%

Source: Morningstar

(Total return is a useful metric for measuring the performance of your shares, as it captures the effects of share price changes and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

One of Shell's key advantages is that it has the size and engineering ability to take on the very biggest projects, something that is increasingly important today. Many new projects -- especially those involving LNG -- are massive in scale and complexity, and require huge initial outlay.

Although Shell's trailing 10 year average total return is slightly below that of the FTSE 100 as a whole, Shell's financial strength and earnings power makes it attractive as a retirement share, as we shall see.

What's The Score?

To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how Shell shapes up:

Year founded1907
Market cap£140bn
Net debt£14.1bn
Dividend yield4.7%
5 year average financials
Operating margin9.1%
Interest cover28.15x
EPS growth20.6%
Dividend growth10.1%
Dividend cover2.5x

Source: Morningstar, Digital Look

Here's how I've scored Shell on each of these criteria:

LongevityShell's oil trading history stretches back to 1892 and the company merged with Royal Dutch Petroleum in 1907, so full marks in this category.5/5
Performance vs. FTSEShell's long-term performance is similar to that of the FTSE 100 but its peaks and troughs tend to come at different times to those of the index. This will help to smooth out the performance of a diversified portfolio or retirement fund.4/5
Financial strengthA solid and profitable company with low debt levels and a better credit rating than some European countries.5/5
EPS growthA strong record of earnings growth at rates well above inflation.4/5
Dividend growthDividend growth is inconsistent and the dividend has remained unchanged for the last three years. However, the yield is attractive and longer-term average dividend growth is well above inflation.3/5

Total: 21/25

A score of 21/25 is the best yet in this series, and suggests that Shell is a strong candidate for a retirement fund portfolio. Its ability to grow earnings over the long-term is valuable and should provide a dependable dividend income, although you shouldn't expect a consistent increase every year.

Finally, if you are interested in dividend-paying retirement shares, I would strongly suggest you take a look at some of Neil Woodford's choices. Neil is one of the UK's most successful fund managers and specialises in identifying companies with strong income potential. You can find out about eight of Neil's biggest holdings in this free Fool report, "8 Shares Held By Britain's Super Investor", which I strongly recommend, as many of Neil's picks are excellent retirement shares.

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Further investment opportunities:

> Roland owns shares in Royal Dutch Shell.

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4spiel 16 Jul 2012 , 3:38pm

Less than a year ago you could have had Shell fo about 1800p Investors should beware being tempted into shares that are ramped up on money printing by the banks. RDS could become with others - YOUR ONE WAY TICKET TO PENSION CREDIT -FREE COUNCIL TAX AND ALL THE FREEBIES WHEN YOU LOSE YOUR SHIRT !!! FANTASY?

dubaiexpat 16 Jul 2012 , 4:55pm

... and if you had bought 4 years ago you could have had them for just over £12 !!! ... and all the divi since then !

I'm probably way too long on RDSB (think Aviva and well known MF scribes) but I still prefer for the long haul compared to plenty of others.

If you understand the animal you understand the risk. They are geographically diversified with good exposure to the East (recovery play), solid assets, really big long long term cash flow projects and not given to flights of fancy.

Geopolitical risk exists, as does the ever present safety issue given complexity of many of the assets so you pay your money and you take your choice, but lose your shirt ... I don't think so. Even BP problems shareholders still own their shirts even though they have shrunk a bit and given time I see them stretching back.

4spiel 16 Jul 2012 , 7:41pm

Yes the P/E of RDS could rise to 20 -indeed some others too and this is the cliffhanger we face. How much risk you take -or whether you just spend less cash and make up for low interest rates by saving more cash. Then ultimately your safety lies wioth the FSA and does the FSA ever tell us how they would pay if they had a queue a mile long from Halifax Midshires and all the rest. If the BOE printed even more paper what would Libor eventually be !!!!!

Gengulphus 18 Jul 2012 , 1:57pm

In this article I've focused on Shell's class B shares, which pay dividends in pounds and are most commonly held by UK investors. Shell also has class A shares -- Royal Dutch Shell (LSE: RDSA) -- which are virtually identical but pay dividends in euros. The total value of these two types of share gives Shell its £140bn market cap.

It should be pointed out that the difference isn't just one of the currency in which the dividend is paid, but also of taxation. Dividends paid on the A shares are taxed as normal for a Dutch company (which is what Royal Dutch Shell actually is), which means that 15% of the dividend declared by the company is deducted at source as 'withholding tax' and sent to the Dutch taxman.

On the other hand, dividends paid on the B shares are paid under a special arrangement that treats them as dividends paid by a UK company under the UK tax system. That system is somewhat weird, but the gist of it is that nothing is deducted at source and the investor gets the entire dividend paid by the company, and additionally gets a 'tax credit' that offsets the basic-rate tax due on the dividend, leaving no UK tax to pay unless the investor pays tax at higher rate or above.

So for UK investors, the A shares end up paying 15% less income than the B shares (despite the two classes of share always having the same declared dividend) if the investor is a basic-rate taxpayer or holds the shares in an ISA or other tax shelter - i.e. there is not just a currency difference, but also a difference in the amount you end up with. (If the investor is a higher-rate taxpayer or above and holds the shares outside any tax shelter, that difference in the amount the investor ends up with normally disappears. That's because the Dutch tax paid on the dividend can be offset against the UK tax due on the same dividend, and in those circumstances the investor normally has enough UK tax due on the dividend to be able to offset the full 15% withholding tax against it.)


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