Shell: a Buy After Latest Results
Royal Dutch Shell plc (RDS-A) (RDS-B) released its second quarter 2016 results on 28th July. The company reported current cost of supplies (CCS) earnings attributable to shareholders of $ 0.2 billion compared to $ 3.4 billion for the year ago quarter. The adjusted CCS earnings after excluding identified items decreased 72 % from $ 3.8 billion for the second quarter 2015 to $ 1.0 billion this time.
Some positive aspects:
However, there were enough positives to take from the company’s performance during the quarter.
There has also been some improvement in the total shareholder return at Shell over the last 12 months. Shell generated $ 2.3 billion of cash from operations and disbursed $ 3.7 billion to its shareholders. The cash flow from operations includes negative working capital movements of $ 2.5 billion. Shell’s 12 month rolling free cash flow was minus $ 13 billion including the BG Group consolidation. Excluding BG, it was about negative $ 6 billion on an organic basis.
Gearing ratio increased significantly:
There was a sharp increase in the gearing ratio primarily due to the impact of the $ 53 billion BG Group acquisition. The gearing ratio at the end of the second quarter 2016 was 28.1 % versus 12.7 % at the end of the second quarter 2015. This has got to improve over time if Shell aspires to become a “word-class investment case”. And for the gearing ratio to improve, Shell’s divestment program will have to be successful under which it is expected to raise $ 30 billion by the end of 2018.
Market conditions and Future prospects:
Oil and gas prices are now on the rise. The worst of this down cycle can be said to be over. But there is a long way for these commodities to go before Shell comes into a comfortable position. Even after all the planned asset sales and CAPEX reductions, Shell needs to generate a much higher amount of cash from its operations to meet its business commitments as well as to pay out its debt and dividends.
Last month, the US Energy Information Administration upped its 2017 price forecast for Brent crude from $ 49 per barrel to $ 52 per barrel. But in my opinion, even a $ 50 or $ 60 per barrel oil price won’t do much good to Shell’s balance sheet which is laden with huge liabilities. The company needs at least a price of $ 80 per barrel to generate enough operating cash flow to fund its future and meet its commitments.
However, it’s not only oil that Shell sells now. After the BG Group acquisition, it has become the largest producer of LNG (liquefied natural gas) in the world. In fact, LNG accounted for over half of the company’s revenue in the most recent quarter. Shell will definitely enjoy this position because many coal fueled power plants are expected to shift to gas in the future. Further, natural gas is also going to see its share increase in the world of automobiles in future. But that’s far into the future. Still, what the BG acquisition has done to Shell is that it has provided more strength and diversification to its asset portfolio.
But the BG acquisition has also made Shell’s balance sheet heavy with debt and left it with only little liquidity on the asset side. This would be a huge risk to the dividend pay-out tradition at Shell which has run uninterrupted for the last 70 years now. The BG acquisition will be fruitful only if oil hits the mid $ 60s which is unlikely in the near term.
Therefore, it won’t be wise to buy or hold Royal Dutch Shell at present when there are much more promising options floating around in this sector.