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Royal Dutch Shell - Cash now free to flow

Nicholas Hyett | 26 July 2018 | A A A
Royal Dutch Shell - Cash now free to flow

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,392.60 | Buy: 1,393.00 | Change 30.00 (2.20%)
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Shell's first half profits rose 36% to $10.3bn on an underlying basis. Higher oil & gas prices boosted results in the Integrated Gas and Upstream divisions, partially offset by lower margins in Downstream and increased costs across the group.

The quarterly dividend remains unchanged at $0.47 a share, with Shell also announcing a $25bn share buyback to be completed over the 2018-2020 period.

The shares fell 1.4% in early trading, as earnings came in slightly behind market expectations.

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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 may not be quite what was hoped for this time out, but that's a minor setback.

Having nursed the dividend through the bad times, Shell's now got the cash to reward shareholders for their loyalty, starting with a $25bn buyback at $2bn a quarter.

The driving force behind progress has been a dramatic improvement in oil prices, but Shell deserves credit too. Operating expenses have been kept under control, and the group has been managing down capital expenditure while still adding more than enough to reserves to replace production last year.

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

Cash is what 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 $9.5bn last quarter.

Unfortunately, there are also monster demands on its cash. Capital expenditure cost $5.3bn last quarter, interest on debt $895m, and dividends $3.9bn.

For now things are being kept ticking over by a huge asset disposal programme, which saw the sale of $2.5bn of assets last quarter. All that extra cash helped Shell cut net debt, and disposals are expected to tick along at over $5bn a year going forwards.

Longer term that cash will be needed to fund buybacks as well. If Shell is to meet all its commitments to shareholders and continue to see net debt fall, it needs to swell its 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 are improving, and there should be scope for more cost savings and production increases. That would 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 5.3%. 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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Half Year Results

First half production remained broadly flat year-on-year at 3.6 million barrels a day. However, the average oil price received rose 35% to $63.38/barrel, with gas prices up 14% to $4.91 per cubic foot.

Profits at the Upstream and Integrated Gas businesses rose 242% and 102% respectively, to $3bn and $4.7bn.

The Downstream division, which includes Shell's refining and sales businesses, saw profits fall 32% to $3bn. Lower profits were largely due to results in the Refining & Trading business, where increased maintenance and higher costs both dented performance.

Shell completed around $3.8bn of disposals in the second quarter, across Upstream and Integrated Gas. The company also announced a large deep-water discovery in the US Gulf of Mexico, with new exploration contracts signed in Mauritania.

Increases in working capital meant that operating cash flows were actually 9% below this time last year. But net debt was still 6% lower than in the previous quarter at $62.2bn, with gearing (net debt as a proportion of total capital) falling 1.1 percentage points to 23.6%.

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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.