Shell (LSE: DSB) is more likely to double than Anglo American (LSE: AAL), but Anglo is more likely to halve in value than Shell, in my view. Here’s why.
Shell’s Break Fee/Dividend Ratio
“Some of this year’s largest takeover deals are at risk of falling apart — including Shell’s $70bn bid for UK rival BG,” The Financial Times reported this week.
There have been all sort of rumours this week, really, and whilst I agree that Shell may encounter some difficulties to wrap up its acquisition of BG by early 2016, I have no inside information to share with you on this story. I know, however, that there’s a 1.6% break fee on the original value of the deal — that’s £750m ($1.2bn).
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The break fee is the amount that Shell will have to pay to BG if it decides to walk away.
Break fees could be as high as 10% of the value of any acquisition, so Shell would not pay much on an absolute basis, considering that BG was initially valued at over £45bn, but here’s my advice: think to the break free as a percentage of the total dividend that Shell paid last year.
A 13% Ratio: How Good Is That?
Well, 13% is the number you are looking for!
Shell’s cash flow & capex profile is going to be pretty tight this year, and its projected free cash flow yield is 0.99%, according to my calculations, but it plummets to 0.14% if the break fee is deducted.
Of course, Shell could use cash on hand ($26bn) to finance its dividends, but I doubt investors would perceive it as being a sign of solidness in its core operations. Just when commodity companies count the pennies, I also doubt that Shell would be happy to throw to waste $1.2bn, particularly because of the synergy potential that is being offered by BG.
You may not want to bet against the market now, and there are obvious risks with Shell, but its multiples and a few other elements point to upside of between 40% to 160% to the end of 2016, depending on different scenarios for oil prices.
Anglo American
To take an informed decision about Anglo’s prospects, we just need to go through its latest trading update for the six months ended 30 June 2015.
Net debt (including related hedges) of $13.4bn was $625 million higher than in December 2014, and $1,9bn higher than at the end of June 2014.
Net debt is the difference between cash and cash equivalents of $7bn (31 December 2014: $6.7bn) and gross debt including related derivatives of $20.5bn (31 December 2014: $19.6bn), as Anglo says.
The increase in Anglo’s net debt position was driven by capex of $2,1bn, the payment of dividends of $680m to shareholders and $196m to non-controlling interests, and interest payments of $456m — which was partially offset by cash generated from operating activities of $2.7bn.
So, Anglo is increasingly using debt to support its rising dividends (7.7% forward yield), but in doing so its net leverage could become problematic if the current turmoil doesn’t subside. This signals that a dividend cut could be around the corner, particularly if proceeds from divestments disappoint, just as it occurred this week with the sale of its copper mines in Chile.
