Shell’s value gap is more strategy than geography
19/04/2024 06:00
(The author is a Reuters Breakingviews columnist. The opinions
expressed are her own.)
By Yawen Chen
LONDON, April 19 (Reuters Breakingviews) - It is
generally a good thing when a chief executive worries about his
company’s share price. The danger is seeking superficial fixes.
Ever since Shell SHEL.L CEO Wael Sawan took charge last year,
he has made it his mission to close the $230 billion oil giant’s
valuation gap with U.S. rivals like Exxon Mobil XOM.N . If his
efforts fail to produce results by 2025, however, he has
threatened to consider “all options” including shifting the
UK-based company’s primary listing to the United States, he told
Bloomberg last week. The problem is that Shell’s value gap is
due to more than just geography.
Sawan is not alone in wondering whether his company’s
domicile is weighing on its value. In the past few years, a
growing band of companies, including plumbing parts specialist
Ferguson FERG.N and online gambling group Flutter
Entertainment FLUT.N have switched their stock market listings
from London to New York in search of a different shareholder
base and higher multiples. A transatlantic switch for Shell
would be on a different scale, though: it is currently the
largest company listed in the United Kingdom, accounting for
over 9% of the benchmark FTSE 100 Index .FTSE .
It is easy to understand Sawan’s valuation frustration. All
big oil groups produce a fungible commodity which trades in a
global market. And though European groups including Shell have
traditionally traded at a discount to U.S. oil giants, the gap
has widened in recent years. In 2018, for example, Shell’s value
including debt was around 6 times expected EBITDA for the next
12 months, according to LSEG data, while Exxon was valued at 7
times. The European group now trades at a 4 times multiple,
while its $470 billion U.S. rival is on 6 times.
To explain the difference, start with strategy. In the past
few years, oil groups have faced mounting pressure from
investors and regulators to diversify their businesses and
prepare for declining demand for the black stuff. But while many
European executives acknowledged a future with less oil,
American bosses like Exxon’s Darren Woods have been less willing
to shift.
Ben van Beurden, Sawan’s predecessor at Shell, invested
heavily in the energy transition, pouring cash into wind and
solar power, biofuels, hydrogen, and charging points for
electric vehicles. While his successor has pulled back from
renewable energy as higher interest rates depressed returns,
Shell still invested around 20% of its cash capital spending on
low-carbon assets in 2023. By contrast, Exxon spent about 2% on
low-carbon solutions that primarily focused on capturing and
storing carbon emissions.
Differing priorities in allocating capital are also evident
in oil, which remains the companies’ most lucrative activity and
their main source of earnings. In 2021, Shell decided to aim for
an expected reduction in oil production of around 1% to 2% each
year until 2030, including divestments and the natural decline
of existing oil fields. While Sawan retired that goal last year,
he still expects Shell’s total oil and gas production in 2030 to
be roughly the same as in 2022.
Meanwhile, Bernstein analysts expect Exxon’s total
production to grow at a compound annual growth rate of 6% over
the same period. The analysts expect Exxon’s oil output alone to
grow at a 7% compound rate thanks to investments in Guyana and
its recent $60 billion takeover of Pioneer Natural Resources
PXD.N , which boosts growth in U.S. shale. As a result,
analysts expect Exxon to report EBITDA of $80 billion in 2025,
8% more than last year, while Shell’s EBITDA will decline by 10%
over the same period, according to forecasts compiled by LSEG.
This divergence matters to investors in oil companies
because earnings underpin those companies’ ability to pay
dividends and buy back stock. European groups have proved
themselves less dependable on this front by slashing payouts
after oil prices collapsed during the Covid-19 pandemic. In
2020, Shell more than halved its annual dividend to $7 billion;
Exxon kept its distribution to investors steady at $15 billion.
Companies like Shell and its British rival BP BP.L have
also been less strategically consistent. Under van Beurden, for
example, Shell planned a big push into chemical products, only
to unwind many of those investments due to poor returns.
While Sawan has focused on cutting costs and improving
shareholder returns, investors are so far not giving him much
credit. Shell’s free cash flow yield – the cash a company
generates after capital spending, divided by its market value –
is currently 12%, against 7% for Exxon, LSEG estimates show.
It is true that European oil companies face other specific
factors that lessen their attraction in the eyes of investors.
The continent generally has more punishing taxes for fossil fuel
producers, while its lenders are more reluctant to finance oil
groups.
Still, on balance switching Shell’s listing to the United
States would not close the valuation gap. Indeed, the company’s
highly liquid stock can easily be bought by U.S. fund managers
in London or through American Depositary Receipts traded in New
York. While Shell’s shareholder structure is highly fragmented,
among its top 100 investors – who hold around a third of the
company’s stock – over 40% is already held by U.S. investors.
One transatlantic difference is that U.S. investors have in
recent years cooled on allocating capital according to
environmental considerations, while European money managers are
still more likely to consider a company’s green credentials. If
Sawan wanted to shift Shell’s strategy more aggressively in the
direction of pumping more oil, he might therefore find a more
receptive investor base in the United States.
However, tapping into those investors would require a big
effort and considerable risk. In order to be eligible for U.S.
benchmarks like the S&P 500 Index .SPX , Shell would not only
have to move its primary listing stateside, but also shift its
head office and senior executives. The company would have to
switch from international to U.S. accounting standards. And
Sawan would have to persuade three-quarters of Shell’s current
shareholders to approve the move, even though index-tracking
funds would be forced to sell when the company dropped out of
the FTSE 100 benchmark. The benefits of moving would also take
time to flow through. For example, the $43 billion Ferguson,
which moved its primary listing to the United States in 2022, is
still waiting to join the S&P 500 Index.
Sawan’s frustration with his company’s valuation gap is
understandable. But the reasons for the divergence defy a
superficial fix.
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CONTEXT NEWS
Shell’s Chief Executive Wael Sawan said he would have to
“look at all options” including switching the group’s listing to
New York if efforts to close a valuation gap with U.S. rivals
Exxon Mobil and Chevron in a ten-quarter “sprint” from its last
capital markets day in June 2023 don’t work, Bloomberg Opinion
said on April 8, citing an interview with Sawan in March.
Ben van Beurden, former Shell CEO and Sawan’s predecessor,
said Shell is “massively undervalued” in London and may benefit
from switching its listing to the U.S., the Financial Times
quoted him as saying on April 9.
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Graphic: European majors’ earnings growth lags US peers https://reut.rs/3UksUxg
Graphic: Shell and Exxon’s valuation discount widened https://reut.rs/3W2hQpJ
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(Editing by Peter Thal Larsen, George Hay and Oliver Taslic)
((For previous columns by the author, Reuters customers can
click on CHEN/
yawen.chen@thomsonreuters.com; Reuters Messaging:
yawen.chen.thomsonreuters.com@reuters.net))