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Royal Dutch Shell - Upstream back in profit

Equity research team | 1 November 2016 | A A A
Royal Dutch Shell - Upstream back in profit

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Royal Dutch Shell Plc A Shares EUR0.07

Sell: 1,450.80 | Buy: 1,451.20 | Change 27.00 (1.90%)
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Upstream back in profit

Royal Dutch Shell continues to hold the dividend steady at 47 cents a share. Third quarter earnings, before exceptional items, were 35 cents per share on a current cost of supply (CCS) basis, down 8% on a year previously.

The share rose 3% following the announcement.

Our View

Shell, in common with other oil companies, has been enjoying some respite of late, as oil prices have bounced from their lows and lower sterling has boosted the value of dividends. That won't be enough to assuage all investors' fears, but it should push some of the Armageddon scenarios off the table.

Shell is sticking to its previous dividend commitments - despite around a third being paid in shares as the company struggles to meet all the demands on its cash flow. 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, the company seems prepared to let its balance sheet take the strain.

The scale of planned reductions in operating expenses following the merger with BG are almost unfathomable. As the group tries to preserve cash flow in the face a stubbornly low oil price, clearly there have been no sacred cows. Capex plans are similarly pole-axed and the group should emerge as a leaner and fitter animal at the end of it all.

Shareholders should not doubt Shell's intention to pay up. 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. With the prospective dividend yield now over 7.5% investors seem to be questioning whether the current rate of pay-out can continue without a more sustained oil price recovery.

Third Quarter Results:

The integration of Shell and BG is now "essentially done" according to CEO Ben van Beurden, boosting performance this quarter.

The group's upstream division turned a symbolically important, but still measly, profit of $4m in Q3; that compares to losses of $1.3bn in Q216 and $0.6bn the previous year. The integrated gas and downstream divisions have continued to deliver steady performances, although lower oil and gas prices continue to impact performance when compared to a year previously.

Operating costs are expected to be $40bn in 2016, down $9bn on the combined Shell/BG cost base in 2014, with further reduction expected as deal synergies are delivered in full. Organic capital investment, excluding the acquisition of BG, is expected to be $29bn for FY16 compared to a combined $47bn across Shell and BG in FY14. Capital investment in 2017 is expected to be $25bn.

Cash flow from operations was $8.5bn, up from $2.3bn in Q2 but down 24% on a year earlier. Dividends in the quarter totalled $3.8bn, of which $1.1bn was issued in shares through the scrip programme. Debt at the end of the first quarter, as measured by the gearing ratio, was 29.2%, versus 12.7% in Q315 and 28.1% in Q216.

Projects started in 2016 are expected to add over 250,000barrels a day to group production when fully ramped up. Cash flow from projects started between 2014 and 2018 is expected to total $10bn in 2018, at an average oil price of $60 a barrel.

The group continues to work on the disposal of 16 assets as part of its $30bn asset disposal programme.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

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 for more information.