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Royal Dutch Shell - costs slashed to protect cash

Nicholas Hyett, Equity Analyst | 23 March 2020 | A A A
Royal Dutch Shell - costs slashed to protect cash

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,427.80 | Buy: 1,428.80 | Change 92.20 (6.91%)
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Royal Dutch Shell has taken steps to free up $8-9bn of free cash flow through reductions in operating costs, capital spending and working capital requirements.

The group is also suspending its share buyback programme.

The shares fell 2.6% in early trading.

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Our View

The collapse in oil prices has sent a shockwave through the oil industry. It started with a massive surge in Saudi Arabian supply, when the production agreement between Russia and oil cartel OPEC broke down. But the challenges have now shifted into demand too as the coronavirus outbreak sees economies grind to a halt and fuel usage fall.

Oil majors like Shell are better placed than smaller rivals, but this is still cripplingly bad news for profits.

At $25.52 a barrel the price of Brent crude oil is some 60% below last year's average. All things being equal that implies 60% lower revenue in the upstream division and potentially integrated gas as well - that would potentially make these divisions significantly loss making. With lower demand likely to hit the downstream - which includes the production and sale of oil derivatives and petrol stations around the world - there's a genuine risk that profits get wiped out if current prices persist.

There's nothing Shell can do to influence the price of oil though. Just as the crash came out of the blue predicting a recovery is likely to be equally thankless. A renewal of the OPEC/Russia agreement could be just around the corner or the relationship may be unsolvable. Instead management are, quite rightly, focussing on the things they can control.

The first order of the day, as in so many industries at the moment, is conserving cash. It's cash that pays staff, services debt and, crucially, funds the dividend.

Shell is taking a hatchet to the cost base, taking around 10% of operating costs over 12 months and 20% off planned capital investment. Shareholder returns are being reigned back too, with the next tranche in the $25bn buyback programme suspended. Even then keeping the balance sheet in good health is reliant on $10bn of asset sales that will be more challenging in low oil price world.

The motivation behind the drastic action, we suspect, is sustaining the dividend - Shell hasn't cut its payment since the Second World War. But the annual dividend payments set Shell back $15.2bn last year, and with the shares currently offering a prospective yield of 14% the market is clearly worried that unprecedented circumstances will result in an unprecedented cut.

We think the actions taken today will keep the dividend in place for now. However, if oil prices continue to slide along the floor the dividend is going to become more and more of a burden and eventually Shell will have to crack. The rub for CEO Ben van Beurden is that after a certain point the group's future is out of his hands.

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Coronavirus Actions

Shell expects to reduce underlying operating costs by $3-4bn a year over the next 12 months compared to 2019. Capital expenditure is expected to fall to $20bn or below, compared to previous expectations of $25bn.

The group is still committed to $10bn of asset sales in 2019-20, although timing will depend on market conditions.

Shell has around $20bn of cash on hand, with $10bn of undrawn credit lines.

The company expects to announce a quarterly update on 31 March with first quarter results on 30 April.

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