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Royal Dutch Shell - Impressive Downstream boosts performance

Nicholas Hyett | 2 November 2017 | A A A
Royal Dutch Shell - Impressive Downstream boosts performance

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Royal Dutch Shell Plc A Shares EUR0.07

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Underlying profits in the third quarter were 47% ahead of this time last year, at $4.2bn on a constant cost of supply basis. That reflects improvements across all three operating divisions.

The dividend remains unchanged at 47 cents a share. The shares rose 1% in early trading, as earnings came in ahead of expectations thanks to a strong Downstream performance.

Our View

There's a lot to like in Shell's results, with all the major metrics heading in the right direction. The strong free cash flow performance is particularly eye catching, more than covering the cash portion of the dividend and raising the possibility of scrapping the scrip dividend (where a company pays its dividend in new shares) this year.

Achieving that while being paid less than $50 a barrel and carrying out and integrating the major BG acquisition, is undeniably impressive. However, much of the profit is coming from the downstream business rather than the wellhead, where low prices continue to hold back performance.

If we had a slight concern it's that capital expenditure remains at rock bottom, and well behind the combined total of depreciation and asset sales. The group is performing well for now, but at some point it will have to fork out to replenish the oil it's currently pumping and selling.

The still significant debt pile may hamper investment in the near term and could continue to soak up cash, holding back dividend growth to boot. While asset sales and an improving cash flow position mean net debt is falling (down $10bn since this time last year), Shell would still need to repay around $30bn if it wanted to return to the level of gearing it had before the BG deal.

Fortunately the group still has some way to go on its planned asset disposals and that should provide a cash infusion. Shell has also taken $10bn of operating costs out of the combined BG/Shell business relative to two years ago, boosting profits.

The prospective yield has come back a bit in recent months, a reflection of the group's improved cash position, and currently stands at 5.8%. This remains an attraction, but with plenty of other demands on the group's cash, growth might be a little low on the ground in the near term.

Third Quarter Results

Shell's improved performance reflects a 2% increase in production year-on-year, 1% fall in underlying operating expenses and significant improvements in the price received for its oil & gas products.

The Downstream business was the largest contributor to profits, with underlying earnings of $2.7bn, representing a 28% increase on a year ago. That improvement was driven by an exceptionally strong result in Refining & Trading, partially offset by a weaker performance in Marketing.

Underlying earnings in Upstream, which includes the group's oil & gas production assets, saw earnings leap from just $4m a year ago to $562m this quarter. With production falling 1% compared to the same period last year, that was largely driven by an improved price environment.

Shell's Integrated Gas business saw profits rise 38% to $1.3bn as the group benefited from higher realised oil, gas, and LNG prices, as well as higher production and LNG liquefaction volumes.

The group completed $1.4bn of asset sales in the quarter, largely made up of the group's 50% stake in the SADAF petrochemicals joint venture Saudi Arabia and 10.37 million common units by Shell Midstream Partners.

Free cash in the quarter was 10% ahead of the previous year, at £3.7bn. Net debt of $67.7bn fell 13% versus a year earlier, although crept up slightly quarter-on-quarter.

Shell paid $4bn of dividends to shareholders in the quarter, of which $0.9 billion was paid in shares.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.