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Royal Dutch Shell - improvements from a low base

Nicholas Hyett, Equity Analyst | 29 October 2020 | A A A
Royal Dutch Shell - improvements from a low base

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Royal Dutch Shell Plc B Shares EUR0.07

Sell: 1,555.00 | Buy: 1,555.80 | Change -93.00 (-5.64%)
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Royal Dutch Shell's total third quarter revenue was $44.7bn, down from $89.5bn last year, reflecting lower oil & gas prices and, lower production and weaker margin in downstream. Although total costs fell from $81.2bn to $44.3bn, the group reported profits of just of $489m, down from $5.9bn. Organic free cash flow rose from $6.6bn to $6.7bn.

Shell declared a dividend of $0.1665 per share, down from $0.47 last year.

The shares rose 1.4% following the announcement.

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Our View

The recent collapse in oil prices 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 saw economies grind to a halt and fuel use fall.

Oil majors like Shell are better placed than smaller rivals, but this was still cripplingly bad news for profits. Underscoring the severity of the situation, management felt the need to cut the dividend for the first time since WWII. The language of a "reset" indicates that this is a permanent reduction and not a temporary measure.

There's nothing Shell can do to influence the price of oil though. Just as the crash came out of the blue, predicting the path of a recovery is likely to be equally thankless. The oil price has recovered a bit since hitting its nadir and the group is generating free cash, but Shell really needs a higher oil price if it's to make the kind of profits investors had become accustomed to. The group reckons $60 a barrel as a long term average, but the oil price has been below that for much of the last 5 years.

It's no surprise then that Shell is taking a hatchet to the cost base. Aside from cutting the dividend the group is on track to take $3-4bn off operating costs over 12 months and 20% off planned capital investment. Despite those efforts impairments to asset values have been pushing up gearing in the short term, although gearing fell slightly in the last quarter, and this could mean keeping the balance sheet in good health requires further asset sales.

In the long run the cash freed up may help the group transition away from fossil fuels. We think this is probably a long way off though, and relies upon a profitable core oil & gas business for funding.

Shell certainly has a tough time ahead of it. The group's resources are immense but not infinite, and it needs higher oil prices before it can get back onto the front foot. While we think demand for oil will strengthen again once the world economy recovers from COVID-19, how long that takes and what scars Shell is left with remain to be seen.

Shell key facts

  • Price/Book ratio: 0.48
  • 10 year average Price/Book ratio: 1.2
  • Prospective dividend yield (next 12 months): 6.6%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

Total production fell 14% to 3.1m barrels of oil equivalent per day (boepd).

Integrated Gas underlying profits fell 71% to $768m, largely because of lower realised prices and trading profits, partially offset by lower costs. The division also wrote down the value of its assets by $924m, primarily relating to the Prelude floating liquid natural gas operations in Australia.

Upstream underlying profits fell from$833m in the third quarter of 2019 to an $884m loss in the same quarter this year. The loss primarily reflects lower realised prices and lower production volumes due to OPEC+ restrictions and bad weather in the Gulf of Mexico. The division also wrote down the value of its assets by $101m and lost $100m selling assets.

The Oil Products division made $1.7bn in underling profits, down from $2.0bn last year. The fall reflects lower refining margins and lower marketing sales volumes, partially offset by stronger marketing margins, favourable tax movements and lower operating costs.

Underlying Chemicals profits rose 1% to $227m, as favourable tax movements offset lower margins. Corporate costs fell from $817m to $792m, as higher costs were offset by currency movements and higher tax credits.

Cash capital expenditure fell from $6.1bn in the same quarter last year to $3.7bn, and gearing (net debt as a percentage of total capital) rose from 27.9% last year to 31.4%, but fell compared with last quarter (32.7%).

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.