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Royal Dutch Shell - Debt falls as cash generation remains strong

Nicholas Hyett | 4 May 2017 | A A A
Royal Dutch Shell - Debt falls as cash generation remains strong

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,801.00 | Buy: 1,801.20 | Change 6.00 (0.33%)
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A significant improvements in performance from the Upstream division led Shell's profits up to $3.4bn, a 315% improvement on this time last year. The dividend is maintained at 47 cents a share.

The shares rose 2.8% following the announcement.

Our View

A much improved oil price has helped put Shell on the road to recovery. While there's still some way to go before the group climbs out of the well in which the oil price collapse left it, early signs are promising.

Cutting capex and costs to the bone means it's converting more of its earnings into cash, and as a result the cash portion of its dividend is now well covered by free cash flow. If oil prices don't fall again that should at least put minds at rest about the viability of the current dividend rate.

Following the acquisition of BG, Shell is heavily indebted, resulting in interest payments last year of $3bn. Asset sales and an improving cash flow position mean that net debt is falling (down $1.3bn this quarter), although the group would still need to repay around $35bn of debt if it wanted to return to the level of gearing it had before the BG deal.

Debt repayments are likely to soak up spare cash in the near term, which will in all probability hamper dividend growth. We'd also really rather that the group scrapped a scrip dividend policy that is increasing its dividend liability every year even if the payout per share remains unchanged. The policy helped it conserve cash in the dark days, but is also creating future liabilities and diluting shareholders.

The group is only halfway through its planned asset disposals, although the rate of disposals should tick up from here. Shell has taken $10bn of operating costs out of the combined BG/Shell business relative to two years ago, but there is probably more to be done.

With the prospective yield for the next financial year currently sitting at 7.2 %, the market is clearly still nervous about the future and with the company's fate in the hands of the oil price that's not surprising. Until debt is firmly back under control the company will lack the resilience to deal with a major retreat in oil prices, which could quickly see the balance sheet placed back under the microscope.

First Quarter Results

First quarter production was 2% higher than last year at around 3.8m barrels a day, with an average oil price of $48.36, up 64% on Q2016.

Improved oil prices meant that the Upstream division delivered a particularly strong performance, moving from a £1.4bn loss in the same quarter last year to a profit of £540m.

Integrated Gas (the BG legacy business) also saw performance improve, with profits hitting $1.2bn. Downstream, the refining and sales operations, saw profits rise 24% to $2.5bn thanks to a significant improvement in Chemicals amidst tightening market conditions in the Americas.

Operating expenses were 8% lower in the quarter at $9.3bn, while capital expenditure was substantially lower at $4.3bn compared with $5.3bn in the previous year.

Positive free cash flow of $5.2bn allowed the group to reduce net debt by $1.3bn, supporting a fall in gearing from 28% in Q4 2016 to 27.2%.

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.