Royal Dutch Shell -- Here's Why You Should Buy This Stock Now

It is hard to imagine that a blue-chip company such as Royal Dutch Shell  (RDS.A) could become significantly undervalued given all the money that chases the larger-cap stocks.

That is generally why I try and follow young companies that have yet to hit their strides. If I can learn about a young company before everyone else looks at it, I can move in opportunistically after good news arrives.

What attracted me to Royal Dutch Shell was its 7.2% dividend yield. A yield that high suggests that the market believes that a dividend cut is coming, but after I looked at the company presentation, I'm not sure that is true.

Going forward it appears that Shell is going to be able to generate more free cash flow at $60-a-barrel oil than it was in the years when oil cost $90 a barrel. 

Take a look at the company projections in the slide below:

Image source: Shell corporate presentation

The increase that the company is projecting is not a minor amount. From $12 million in 2013 to 2015 Shell now thinks it can generate $20 million to $30 million of free cash flow from 2019 to 2021.

That doesn't just suggest that the current dividend is sustainable; it suggests that the dividend could eventually be increased.

Equally important to note is that this is what Shell thinks that it can do with oil at $60 per barrel. What is the company capable of if oil prices get back up to $70 per barrel and higher?

How Is This Possible?

On the face of it the idea of the company generating more free cash flow at $60 per barrel oil than it did at much higher oil prices doesn't make a lot of sense. The key thing to be aware of though is that we are talking about free cash flow, as in after capital spending.

In the years 2013 to 2015 Shell was spending a massive amount of money on projects with long lead times that it had committed to years before. Check out the slide below that shows capital expenditures going from a peak of $58 billion down to $25 billion to $30 billion in the coming years.

Image source: Shell corporate presentation

That is a crazy swing in the amount of money that the company is spending. The big dollars spent in 2013 to 2015 are now going to be investments that generate cash flow, and with the recent acquisition of BG Group, Shell has a more direct route to maintaining production levels without having to spend so much money.

This Company Has Gas

What I really like about Royal Dutch Shell is how important natural gas, particularly liquefied natural gas, is going to be. The acquisition of BG Group has made Shell by far the largest LNG producer among the major oil companies.

The reason I like that is because I believe (despite Donald Trump's electoral victory) that coal is on its way out, and it will have to be replaced with natural gas. This will particularly be true in China and also India in the years ahead. That is going to be bullish in the long term for natural gas and LNG.

Given the big increase in free cash flow that Shell claims is coming to the company, I'd say that the current 7.2% yield is sustainable. The long term also looks pretty good with Shell's dominant LNG position.

The yield alone on Shell could beat the market in the years ahead. Throw in an oil price recovery, and this one is off to the races.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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