For many UK investors, there is little to separate Royal Dutch Shell and BP. The two oil majors account for 12 and 7 per cent respectively of the total dividends paid by the FTSE 100 and aside from the odd blip – such as the hit to BP from the Gulf of Mexico disaster – they have been among the most reliable income-payers in the UK over the past 30 years.
However, for FP CRUX UK manager Jamie Ward, the differences in the way the two companies are run are stark enough for him to sell out of one while hanging on to the other. And although he aims to find stocks that can avoid the permanent loss of capital if held in perpetuity, the company he has sold out of isn’t the one that cut its dividend as recently as 2010, but the one that hasn’t cut it since the Second World War – Shell.
Performance of stocks vs index over 20yrs
Source: FE Analytics
Ward focuses on a company’s return on invested capital on a through-the-cycle basis, saying he is not interested in what this figure looks like over the past last five years but how it averages out over the long term
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“That’s why you look at 20 or 30 years’ accounting,” he said. “That’s a really important part of it because if you are investing for the long term, you need to find a business that can re-invest in itself to generate a greater return on invested capital and not swallow up too much cash resource.
“That is ultimately where growth comes from.”
Before Ward gets to this point, he asks three questions: do we understand the business, is it comfortable through the economic cycle, and do we trust management?
The manager said the last of these is the most important as it doesn’t matter how good the returns are on capital employed or invested capital because “if the management is determined to squander it all, then it will squander it”. And, he added, investors do not even necessarily need to meet the management team to work out if they are trustworthy or not.
“How? You read what they say and recall back to what they have said in the past,” he explained.
“When you have read thousands and thousands of notes you get a sense of when they are trying to pull the wool over your eyes by the sort of language they try and use.
“[For example] when they are very clear and open about what they are trying to achieve and how they are going to achieve it and then six months later they go ‘this is what we tried to achieve and this is how we achieved it’ and it is completely different.”
This brings him to FP CRUX UK’s sale of Shell. Ward started to have concerns about the way the company was run in 2015 when it bought BG Group. While he said he didn’t have a problem with this acquisition, he didn’t like the way it was being justified by the management.
“I think the oil price at the time was $50 a barrel or something. And they said the economics of it works like this: if we get over $80 a barrel, we make money on it, and irrespective we will buy back $20bn of our own shares,” he said.
“And it was like, first of all you require an oil price that is 60 per cent higher than where it is, and secondly you are saying you are going to buy back $20bn of something and you don’t know what the price of it is? ‘I’m going to pay $20bn and I don’t care if I get 10 shares or 10,000 shares or 10 million shares?’
Performance of index over 5yrs
Source: FE Analytics
“Imagine you are going to buy a used car. You come out of the test drive and you say, ‘I want that car, and I’ll pay any price for it’. That’s stupid. You wouldn’t do that.
“But that’s basically what they did with their equity. They said ‘we are going to buy $20bn of shares and there’s no limit on the share price’, so that clearly shows management weren’t looking at the things that are important to the shareholders. Which is fairly obvious really, as they’re the ones that are paying for stuff.”
He continues to hold BP, however, saying that he built an earnings model of the company going back to 1972 which showed it can invest in the whole length of the supply chain, allowing it to invest “in the right bit at the right time”.
This means that while it can go through periods of up to five years where it doesn’t generate a sufficient return on invested capital, you can be sure it will manage this over periods of 40 or 50 years.
“That’s proper post-tax, 11 per cent per annum,” he continued. “It’s not huge, but if your cost of capital is 7 or 8 per cent, you’re still making an excess return and you can still continue to compound it.
“And if you are doing this thing where you are trying to get rich slow, you’re getting a little bit of growth in the overall capital, and then you’re getting a 6 per cent dividend yield and you add the growth in the capital to the dividend yield, you are getting a decent return.
“If you look at those businesses over anything like 10, 20, 30 or 40 years, they always outperform the market.”
However, over the next couple of decades there is expected to be a wholesale shift away from fossil fuels. For example, James Anderson, manager of the Scottish Mortgage Investment Trust, recently said “by 2028, we will take for granted that one of the great triumphs of the age has been the transition to renewable energy”. So how does this fit in with Ward’s aim of holding companies forever?
The manager said this is an important point, as BP is not just focusing on oil anymore.
“BP is investing huge amounts in the renewable space but it’s not just BP: all the oil companies are doing it,” he explained.
“If you actually read the rhetoric from the oil companies, most of them are keen on the end of oil because they can lock in energy prices elsewhere. They understand the market better than we do.
“And because my portfolio is split between 25 companies at roughly 4 per cent each and BP is actually more than 4 per cent of the index, perversely if BP does badly, I actually outperform the market, which is bizarre. That’s why I’m not keen on using an index as a building block in a portfolio.”
Data from FE Analytics shows FP CRUX UK has made 31.6 per cent since Ward took charge in 2016, compared with gains of 33.35 per cent from the FTSE All Share and 24.65 per cent from the IA UK All Companies sector.
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
The £63.3m fund has ongoing charges of 0.94 per cent.