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JP Morgan Warns Royal Dutch Shell Investors

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Published: Mar 2, 2015 at 12:24 pm EST

In a report published on Monday, JP Morgan has advised the stock market participants to keep an eye on the “five key factors” that could undermine RoyalDutch Shell plc (ADR) (NYSE:RDS.A) earnings during the first quarter of fiscal 2015 (1QFY15).

JP Morgan is of the view that Shell high-margin assets are under attack on weaker crude prices. The sell-side research firm maintained its $49-56.75 price per barrel estimates for Brent crude. As the news crossed wires, the stock is trading down 1.67% at $64.28 as of 10:59 AM EST.

While JP Morgan remains cautious on European integrated oil companies in general, it has raised several fundamental questions particular to Shell. JP Morgan analyst, Fred Lucas, has noted that the gap between Brent and Western Canada Select (WCS) oil prices has been widening. Brent has somewhat recovered, but WTI price is at a standstill because of abundant shale supplies in the US. Since Shell has an exposure in Canadian oil sand assets, the weaker oil and gas prices could translate into a net loss for Shell Upstream Americas.

Moreover, the Dutch government has signaled stricter production checks on the Groningen gas field, due to seismic risks. The low-cost (and thus higher margin) asset comprised 6% Shell natural gas output in 2014. The field production is to be reduced by 16% in the first half of the calendar year 2015 (1HCY15); a 40% cut to the full-year FY13 output level is expected in FY16.

Additionally, the United Steelworkers (USW), the largest industrial labor union in North America, has hinted towards a possible walk-out on three Motiva refineries, that have a combined capacity of 1.1 million BOPD. Motiva is 50-50 joint-venture between Royal Dutch Shell and Saudi Aramco, and is an important earnings contributor for Shell oil products.

Furthermore, one of the two 70 KPBD trains at Pearl GTL in Qatar, owned and operated by Shell, is currently shut down on a two-month planned maintenance. This another high-margin asset contributed to 30-40% of the group’s earnings in 2014.

The typical lag between the LNG contract pricing and crude prices is 4-6 months. Shell Integrated Gas will continue to show negative effects of the declining oil price, in the coming months.

Considering these factors, JP Morgan has updated small negative EPS changes for Shell in 2015 and 2016. The sell-side firm expects the oil and gas industry giant to realize $586 million and $1,022 million segment earnings from Chemicals, during FY15 and FY16, as compared to its prior estimates of $1,367 million and $1,007 million, respectively.

JP Morgan estimates $6 billion in exploration expenditure and $2.7 billion in exploration expenses in FY15. The sell-side firm had earlier forecasted $5 billion and $2 billion in the aforementioned categories, before the company’s recent guidance. It also revised capital spending projections upwards from $30.5 billion to $34 billion in 2015.

Moreover, the sell-side firm has updated its valuation model with a 25% decrease in upstream operating costs during FY15, and a further 5% reduction in FY16, due to lower royalties and energy costs. It is expected that Shell’s net debt would amount to $23.9 billion in FY15. JP Morgan also does not foresee any more share repurchases during 2015-16.

The revised EPS estimates at JP Morgan now stand at $1.27 and $1.66 during FY15 and FY16, respectively. This represents a 37% and 40% slash over the sell-side firm’s prior projections. The firm reiterates a Neutral rating and £21 price target on Shell stock, assuming a 5.8% flat dividend yield in 2015.

Out of the 16 analysts who cover the stock, six suggest a Buy and 10 recommend a Hold. The 12-month average target price assigned by the analysts to the stock is $72.41.


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