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Royal Dutch Shell - Capital markets day

Nicholas Hyett | 7 June 2016 | A A A
Royal Dutch Shell - Capital markets day

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 2,177.00 | Buy: 2,177.50 | Change -10.00 (-0.46%)
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Shell provided an update to strategy following the completion of the BG merger at a Capital Markets Day on 7th June. Shell shares rose 2.5% on the day.

The group now expects synergies from the deal to reach $4.5bn by 2018, up from the $3.5bn suggested in the deal prospectus. Of this, $4bn are expected to be delivered by the end of 2017.

Operating costs for 2016 are expected to be $40bn - around 20% lower than the 2014 pro-forma level for Shell-plus-BG. Capital expenditure will be capped up to 2020 and is expected to be in the range of $25-$30bn a year.

Following the addition of LNG capacity from the acquisition of BG, the group now considers its integrated gas business, previously a growth area for Shell, to have reached critical mass. New investments in this area will slow with assets managed for cash generation.

Going forward the group will be focussing on growing its chemicals and deep water businesses - announcing today the final investment decision in a 1.5m tonne per annum cracker and polyethylene plant in Pennsylvania. Shale is expected to be a major growth driver for the business beyond 2020 - with the portfolio focussed on North America and Argentina. The group is also exploring investments in 'New Energies' - including hydrogen, biofuels, wind and solar.

The group estimates that organic free cash flow could reach $20-$25bn, with a return on capital employed of 10% by the end of the decade, assuming oil prices of around $60 oil prices. With the group's dividend costing $12bn last year that suggests significant debt repayments, even after allowing for the dividends attributable to the new shares issued to purchase BG.

Our view:

Shell, in common with other oil companies, has been enjoying some respite so far this year, as oil prices have bounced from their lows. Not far enough to give much support to profits, but enough to push some of the Armageddon scenarios off the table.

The company is sticking by its promise to pay $1.88 as a minimum dividend for the year. But presently, this seems unlikely to be covered. Shell would argue that at current prices, the industry will invest so little, that future production will fall, creating a global shortage of oil that will ensure a price recovery. In the meantime, Shell is prepared to let its balance sheet take the strain.

The scale of reductions in operating expenses is almost unfathomable and there have clearly been no sacred cows left to graze undisturbed. Capex plans are similarly pole-axed and the group is clearly going to emerge as a leaner and fitter animal at the end of it all.

Post-BG, Shell is now the global leader in LNG, with a strong presence in deep-water oil and gas production. That is all well and good, but the flip side of these strong positions is that both LNG and deep fields tend to be relatively expensive sources of oil and gas. So Shell is strongly positioned in a high cost energy world, but we are less sure about its standing if there is little further recovery in oil and gas prices.

Investors have to hope that yield support works for them in the meantime. At the current price of around 1750p, and an exchange rate of $1.46 the dividend commitment of $1.88 per share works out at a yield of around 7.3%. That level indicates a degree of worry that the dividend may prove unsustainable.

Shareholders should not doubt Shell's intention to pay. The company's commitment to the dividend is legendary, indeed half of Holland would keel over in apoplectic horror if Royal Dutch Shell ever cut the payout. The question is whether the company will have the choice. Even after cutting anything that moves, (apart from the dividend), Shell's spending plans outstrip its likely cash flows. That means gearing will continue to rise, a process that can only go so far.

So think of Shell as a hedge on your petrol bill. If you own the stock, and notice that your cost of filling up keeps falling further, you should probably expect bad news from your investment. On the other hand, if the cost of the fill-up is starting to hurt, the chances are that your dividends have become more secure.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.