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Royal Dutch Shell - Higher oil prices boost performance

Nicholas Hyett | 1 February 2018 | A A A
Royal Dutch Shell - Higher oil prices boost performance

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,355.00 | Buy: 1,355.80 | Change -17.20 (-1.25%)
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Shell reported underlying full year profits of $16.2bn, up 117% on the previous year, with $4.4bn generated in the final quarter. That reflects improvements in the oil price environment and lower costs.

However, cash flows were behind expectations, at $7.3bn for the final quarter and $35.7bn for the full year.

The shares fell 1% in early trading.

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Our View

There's been a lot to like in Shell's recent results, with all the major metrics heading in the right direction. Profits are up and while cash flow may not be quite as strong as hoped, it's still up 73% on last year.

The driving force behind progress has been a dramatic improvement in oil prices, but Shell deserves credit too. Operating expenses have been falling, down almost $800m in 2017, and the group has been managing down capital expenditure while still adding more than enough to reserves to replace this year's production.

Achieving that while being paid less than $50 a barrel and integrating the major BG acquisition is undeniably impressive.

However, not for nothing do investment bankers say "cash is king".

Cash is the money a company actually has in the bank to fund investment, service debt and pay dividends. Shell is a monster when it comes to cash generation, with operating cash flows of $7.3bn last quarter - despite some one-off headwinds.

Unfortunately, there are also monster demands on its cash. Capital expenditure costs $5.9bn last quarter, interest on debt $840m, and dividends $3.9bn a quarter going forwards (now the scrip dividend has been scrapped).

For now things are being kept ticking over by a huge asset disposal programme, which saw the sale of $17.3bn of assets last year. All that extra cash helped Shell cut net debt by $8bn in 2017, and disposals are expected to tick along at over $5bn a year going forwards.

However, longer term that cash will be needed to fund the "at least $25bn" of share buybacks the group plans to complete by 2020. If Shell is to meet all its commitments to shareholders and continue to see net debt fall, it needs to swell it's already formidable cash flow even further.

Nonetheless, we think Shell's prospects are good - always assuming, of course, that the oil price doesn't catch a cold. Market conditions across all the divisions are improving, there should be scope for more cost savings and production increases. That should drive profits and free cash higher.

The prospective yield has come back a bit in recent months, a reflection of the improved cash position, and currently stands at 5.2%. That remains well above the market average. But with plenty of other demands on cash, growth might be thin on the ground.

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Full Year Results

Quarterly profits were fairly evenly split between Shell's three operating divisions, with Integrated Gas delivering $1.6bn, Upstream $1.7bn and Downstream $1.4bn. This represents an improvement across all three businesses.

The improvement in profitability in Upstream, which explores for and produces oil & gas, is particularly dramatic, having posted a profit of just $54m in the final quarter of last year. That performance was largely down to an improved oil price environment, with production broadly unchanged. For the year as a whole, realised oil prices were 27% high and natural gas prices 17% higher than 2016.

In Downstream, Shell has benefited from an improvement in refinery margins, with profits from refining and trading rising 68% for the year to $2.5bn and driving a 16% increase in Oil Product revenues. The Chemicals business has also delivered a strong performance, with profits of $2.6bn.

Integrated Gas, which includes Shell's Liquid Natural Gas (LNG) operations, saw fourth quarter profits improve by 80% thanks to improved market prices.

Despite cash flow falling behind expectations in the fourth quarter, largely as a result of increased tax expense, full year operating cash flow still represents a significant year-on-year improvement, up 73%.

However, Shell's dividend cost it $3.9bn in the most recent quarter (of which $1.6bn was settled in shares), while capital expenditure in the quarter hit $6.8bn. Together these exceed cash flow from operating activities in the quarter.

Contributions from disposals mean that gearing fell slightly, from 25.4% at the end of the third quarter to 24.8% at year end.

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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.

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.